I'm gonna take a victory lap (and you'll have to trust me on this one). And then get back to kicking myself for not seeing this one coming!
Let me start by telling you a quick story. The scene goes back to mid-September 2014. Yours truly (let's call me MC) was in the pantry during Asia market hours with a coworker named Goofy Man (let's call him GM).
GM: How goes it?
MC: Same sh*t, different day. By the way, you watching crude these days? WTI? This thing might fall off a cliff.
GM: Dude, no way. Bottom of the range. At the most goes to 80's. By the way, have you looked at EM and Europe? Valuation is so cheap!
MC: Dude, valuation can be cheap for who knows how long. But, seriously. Look at this oil thing. Have you been following the Russian headlines?
GM: Russia in turmoil means higher oil prices. Everybody knows that. You want any of these spicy green chilis with your lamb vindaloo?
MC: Yeah, I take whatever else you're not eating. Thanks. Dude, but seriously, look at these production stats on my excel. Oil can take go from here to the 50's or 40's. Have you read Alchemy of Finance by George Soros, this is kinda like the oil glut in the 80's.
GM: Dude this is some good chicken masala.
Back in September 2014, I recommended to researchers and PMs at my firm that oil could collapse 50% or more. I should've made F**k you/retirement money on this trade at the age of 24, turning 25. Sadly, I did not. The oil glut mirrored that of the glut in 1985 detailed in George Soros' Alchemy of Finance (one of my favorite investing books). Maybe he made f**k you money for his crude trade. With that said, the catalyst that led to the glut was not over-extended credit in OPEC nations from the international lending boom back in the 1970's/80's. In this situation back in 2014, the catalyst was the need for Russia to increase sales of crude to meet their budget.
That was my number one insight. The fact that as crude prices fell, Russia would need to sell more quantity of crude to make the same amount of money, attempting to meet their budget. As they sold more, the more crude prices would fall. This would occur in a reflexive process.
Secondly, I did some studies on adjusted vehicle sales and fuel efficiency, showing that the purchase of fuel adjusted car sales globally and US have declined while oil inventory has risen.
Lastly, my most important insight is in the chart below.
Back when I look at crude in September 2014, OPEC market share was at 30-year lows. What that told me was that OPEC had no ability to step in and cut production in meaningful ways to support crude. (crudely circled in red on the chart. Pun intended)
This leads to me kicking myself. Damn it. Why didn't I see it coming?
Nowadays, I haven't looked at crude for a while now. When WTI hit the 40's/30's back in 2015, it became uninteresting. With that said, looking at it global market share today, we are not exactly at the highs either for OPEC market share.
It seems to me that the current fall in crude can continue more.
Production has stayed elevated since the bottom of crude in 2015. Inventory, on the other hand, has even risen since 2015, despite what the small bounce in oil prices might imply. And surprisingly, speculative positioning has risen back to elevated levels before the oil crash.
I'm watching this oil market break out of the range - kicking myself since I should've been short, or at least have told the Goofy Man.
I think we have a lot of downside left.
With WTI falling along with base metals and other commodities, I think we should be in the camp of lower yields and lower breakeven inflation. I know, I know. I was big in the camp of huge inflation, but like the great John Maynard Keynes said, "When the facts change, I change my mind."
Well, in this situation, as a speculator, when the sentiments change, I change my mind. Haha, I know, I know. I'm cheating.
This move also has other ramifications. A lot of US high yield are energy dependent. We are all sitting here thinking why is the VIX so low and what can drive it higher. Hmmm. We will see. (the VIX, is that a MM post to come? Hmm.) Also, the driver for lack of commodities demand, and the fall of crude - could that be driven by something more sinister, like China? (I see a lot of China comments, maybe there will be a China post coming soon).
Thanks guys, good luck with the jobs number tomorrow.