The recent spike in oil underscores how the market is stacked in favour of players with deeper pockets. I believe what we are seeing here is a classic example of a bear squeeze.
Firstly, let’s examine the fundamentals. As we know, the price of oil is driven by the demand for the black stuff and its supply. Looking at the demand side there’s a raft of economic data and recent spate of corporate results which tend to point in one direction, the global economy is beginning to slowdown. The Euro zone is moving in slow motion with many parts of the trading bloc still remaining in an economic quagmire. Japan continues to remain stagnant with lacklustre growth and it looks like it will experience another lost decade. China is definitely in deceleration mode as inventory overload continues to add up and domestic demand shows no signs of picking up momentum.
The US economic recovery, supposedly the strongest link in the chain, might not be what it’s cracked up to be. Recent disappointing retail figures underscore the fact that consumers aren't splashing their savings, from cheaper gas, at the retail stores. In fact, a recent survey showed that households are diverting their savings into rising health care costs. So, cheaper fuel at the pumps isn't juicing consumption. In view of the above, then we can see that on the demand side, there really isn't much that is going to push oil prices moving forward.
If the prospects of higher demand for oil isn't pushing oil price higher then it must be a supply side speculation story. Yes, that view would hold water bearing in mind that inventories are rising at record levels. The glut of oil on the market is now becoming so great that storage is an issue. There are talks about filling up huge tankers and docking them out at sea, like floating oil deposits on the high seas. With oil inventories building up, it’s most likely going to take time for these surplus inventories to work their way out of the system.
Moreover, there is no indication from the largest producer of OPEC, the Saudis, that they are planning to cut output. In fact we are seeing the contrary.
“Two other OPEC delegates, one of whom is from a Gulf producer, said they could not rule out prices dropping to as low as $30-$35 due to weak demand combined with global refinery maintenance in the first and second quarters of 2015,” as reported in CNBC on February 2.
OPEC last November decided against cutting its production despite misgivings from its non-Gulf members. OPEC oil ministers, who decide the group's output policy, are not scheduled to meet until June 5. So, we have no indication whatsoever there’s going to be a change in the supply side issue. Even the recent death of Saudi Arabia's King Abdullah last month has not led to a change in the Saudi oil output policy, which is to continue pumping unabated. Therefore, with global demand for oil stagnating and supplies remaining constant, it can only mean more of a glut of oil on the market moving forward. In view of the fundamentals, there is very little reason to expect oil prices to rise going forward.
So what is this recent spike in oil price down to?
What we might be seeing is a bear or short squeeze.
In other words, oil price is moving sharply higher not due to fundamentals but as a result of it being heavily shorted, then a few big pocket players gang up and bid the price higher. That then forces more short sellers to close out of their short positions, often at huge loses. You get a situation where the deep pockets players bet against the smaller players and it is obvious who wins in the end. It is like a game of poker where you know your opponent has a weak hand, but to see his cards you have got to put more money on the table, which you cannot afford to raise or risk. The deep pocket players know that they have this advantage.
It’s a slippery game and the reality is that more often than not the retailer gets shafted. Only the short sellers with deep pockets can afford to risk runaway losses on their short positions and may prefer to close them out even if it means taking a substantial loss.
The only way to counter act this is to stick to a trading discipline, don't let your losses run. There is no love in marrying your trading position. Better to be a slippery fish than a startled rabbit staring into the headlights when the market moves against you.
You need to keep this in mind; if a trading position looks too overcrowded, it’s time to bug out, evacuate your position swiftly.
Why? Because that’s when the deep pocket players bet against the rest of the market. That’s how a few players get even fatter.
This is what might happen with oil prices over the next trading week. The small retailers come rushing in thinking that oil is about to make a comeback. Mainstream, which is control and managed by the deep pockets will help spin the illusion. They might even engineer the oil price movement to trigger a technical buy signal, again it is all a spin.
But the reality might be oil price moving high on short covering. Then when the herd rush in to buy, thinking that oil is staging a comeback, the deep pockets bet against them again, this time the other way. They take short positions and profit from the fall. Remember it’s a zero sum game. Your green is someone else's losses. Perhaps oil isn't making a comeback, but rather it’s about to tank. It's a tricky game.... At the time of writing this piece oil is at 51.02 USD.