Energy markets turned aggressively lower Wednesday and have continued downwards today. What kicked if off was surprise news from the U.S. Department of Energy that weekly gasoline inventories rose last week by 1.27 million barrels instead of falling as expected, for what would have been the twelfth consecutive weekly fall. Compounding this drop we then saw the International Energy Agency revising lower its 2011 global oil demand forecast for the first time as consumers have begun to react to the strong price rises during 2011.
Gasoline had, up until now, been the driver of the rally and at one stage it came within five percent of the high from 2008. Retail gasoline prices in the U.S. last week reached an average of 3.98 dollars per gallon, very close to the physiological level of 4 which undoubtedly would have increased political pressure for action.
The 21 dollar sell off in crude oil last week happened within 48 hours and left most analysts believing that it had removed enough of the speculative overhang to bring prices back up to previous levels. This has clearly not happened and investors are now faced with a reality check as the popular short dollar long commodity strategy has been unraveling.
The Reuters Jefferies CRB index has not had a losing month since August 2010 and this long stretch of profitable movements have attracted many new investors into the commodity space, with especially silver, corn and oil catching investor’s imagination. None more so than silver where the 50 dollar level was almost reached after a 170% rally over just a matter of a few months.
The main damage to investors, however, has been the strong correction in crude oil over the last week and especially the aggressive manner in which it sold off. In order to understand what has been going on we have to look at the weekly data from the U.S. Commodity Futures Trading Commission.
The below chart shows how the speculative WTI Crude futures positions held by hedge funds and large investors has moved over the last couple of years. During the last few months this has risen to 300,000 futures lots or 300 million barrels. The last major correction during May 2010 triggered a similar 21 dollar sell off over a three week period, resulting in the speculative position being reduced from 150,000 to 50,000 lots. With the supply disruptions having been discounted for, the market attention has turned to the demand side where indicators are now pointing towards a softening in demand.
This has been the trigger for the correction, combined with the revival of the dollar. WTI Crude has underperformed Brent Crude by almost five dollars over the last week, indicating to a certain extent where the speculative positions were held, combined with the fact that U.S. data has been the first to hint of a slowdown in demand.
“Sell in May and go away” is a myth but unfortunately that seems to hold true this year with investors having to review their outlook for commodities given the increased risk that high prices have begun to impact global demand. Fundamentally, investing in commodities still makes a lot of sense but once again we see the impact of what happens when many want or need to exit a relatively small market, compared to bonds and stocks.