Schork Oil Outlook: Dead Volatility = Salvation for Bulls?

Since US markets re-opened after the 04th of July holiday, Nymex WTI for September delivery rallied from a 71.47 low (06th-Jul) to last night’s 79.42 high; an 11% rise in twelve sessions. As such, the spot market now finds itself on the precipice of $80 for the second time since the implosion in the price back in the first half of May.

At the same time volatility has collapsed. The CBOE OVX (so-called "oil VIX") has dropped from 40.24 to 33.59. In other words, confidence in the current price path appears to be growing. That is troubling if you are a bear.

Of bigger concern for the bears (not to mention market fundamentalists) has been the collapse in the front end of the Nymex oil curve. The idiocy of taking a buy-and-hold strategy in a commodity ETF where the underlying curve is in contango is by now well documented.

For instance, yesterday Bloomberg posted a lengthy sob story of investors who bought into the natural gas and crude oil markets vis-a-vis respective ETFs (UNG and USO) on the advice of their ignorant retail equity brokers. Whereas spot month crude oil (rolling contracts) on the NYMEX has increased by 111% since the December 2008 nadir, the USO is up a mere 4½%.

Of course, much of the ETF investor’s potential income was eaten up by rolling a long spot position into a dear outer month contract. However, with the front end of the Nymex curve now inching ever so closer to backwardation the rational of buying into an ETF based on the NYMEX crude oil market does not seem so asinine.

That is to say, if rolling into a dear contract (contango) locks in a loss each month, then rolling into a discounted contract (backwardation) locks in a profit each month. In other words, should the front of the NYMEX WTI board eventually slip into backwardation, the template is set for a rush of bullish momentum as investors potentially flood back into the oil markets to take advantage of the roll.

In this vein analysts at The Schork Reportare keenly watching the natural gas market. The front of the NYMEX curve has now been in backwardation since last Friday. Nevertheless, the amount of shares outstanding in the corresponding ETF (UNG) has dropped by 3.3% since. Should this market remain in backwardation then it makes sense to start buying in the ETFs… and that just might be the catalyst that pushes this market through current resistance in the high 4.60s.


Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.