Last week’s DOE report, like the umpteen reports before it… was patently bearish. For instance, per last Wednesday’s report, transportation fuels (mogas, diesel, jet…) fell, but the draw was once again well below the norm, heating fuels rose and stocks of commercial and government crude oil surged. On top of this, demand continued to wane. Bottom line, supply of inputs is rising and demand for outputs is falling.
As we illustrate in The Schork Report’s Chart of the Day, the market provided a tremendous incentive to go off the Board yesterday long the May WTI contract… assuming you had leased tank space. In other words, not only are supplies flush, but the NYMEX is paying you to store even more barrels.
Last week the Wall Street Journal’s Liam Denning published an article aptly titled “Oil Bulls Should Focus on Wells, Not Wells Fargo”. Mr. Denning suggested that oil’s recent bullish streak is based not on fundamentals but on riding the coat tails of a strong equities market.
Specifically, Mr. Denning wrote:
“From 2001 to Lehman Brothers’ collapse in September 2008, the correlation of oil-price moves with the S&P 500-stock index was about zero, implying near perfect independence. Since then, it has leapt to 36%.”
The implication of near perfect independence is slightly misleading; almost any two real world time series which aren’t directly linked will have near zero correlation over a 7 year period. That’s the weakness of trying to summarize 7 years worth of data in to one value.
However, we agree completely with Mr. Denning’s assumption of higher than expected correlation between the S&P 500 and crude oil (see chart in today’s issue of The Schork Report). The correlation co-efficient for March this year was through the roof. That makes sense, on the back of bearish inventories and weak consumer demand crude should have finished lower, intuitively that is. Instead it saw a 23.7% increase in spot prices for the month of March, following the S&P’s 13.8% increase. Historically, March doesn’t see these kinds of gains in either contract, the average over the 2003-08 period being a 3.7% increase in Crude and a 0.001% decrease in the S&P index. Thus given the size and direction of the price movement, the equities market certainly seems to be pulling up crude. However, how long can we expect this correlation to hold and how can we take advantage of it?
Unfortunately, May presents a less cheery outlook. The contracts sees a weaker, though mostly still positive correlation, which means that oil and the S&P should move in tandem, albeit less strongly than in April. So if the S&P falls, crude will follow, and historically the S&P has a more bearish confidence interval in May, between a 1.5% loss and 2.1% gain. Last year saw oil prices buoyed by the bubble despite the S&P falling, which explains the negative correlation. This year we can’t expect similar strength in oil, so if the S&P falls, it’s dragging crude with it.
The Bottom line is that bullish sentiment in the S&P index should cushion any big shocks in the next couple of DOE reports, but we can’t expect this honeymoon to hold through May. Further, the recent drop in BofA and HSBC stocks as well as Tuesday’s drop in the Nikkei may be enough to end the Bulls’ party prematurely.
(TV Notes: Stephen Schork will appear on The Kudlow Report today at 7pm/ET)
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Stephen Schork is the Editor of, "The Schork Report"and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.