If over the past six months or so it has seemed as if you were partying like it was 1999 it might be time to reevaluate your stance.  One thing that we have been taking a closer look at lately is the pricing of risk.  Obviously when investors think that risks are low they will demonstrate risk seeking behavior.  We have seen this as the SP500 has climbed 56.6% from the March lows to the highs on 8/28/09.  With a rise like that you would think that 2008 never happened, of course if you believe that then you also believe  in a land of make believe with money trees, the fountain of youth, and SI models for all of us.

Of course some investors counter saying that while things could be better we are seeing the beginning of a recovery.  They then say that while the market will likely climb slower, that it will still climb higher.

While the above scenario is possible, anything is possible.  The more important question is to decide if the rewards outweigh the risk involved in being long equities right now.  Or even if at this point the better risk reward trade is to the downside.

Lets look at a few “risk gauges” or “fear indexes” as the press likes to call volatility indexes.  The first is of course the VIX.  After spiking to all time highs in October and November of 2008 we are already well on our way towards what was considered a “normal” level back in early 2008 before Bear Stearns.  The potential risks were obviously very mispriced at the beginning of 2008, are they mispriced again?  While likely not as off as they were at the beginning of 2008 we still think that there are a lot more real and potential risks then the market is currently pricing in. (Click on chart to enlarge)

SP500 VIX

What about foreign markets?  How do investors perceive the potential risks abroad?  Well if the VDAX is any gauge then investors see a rosy future in Europe as well.  Again maybe there are no big risks and maybe the EU is rock solid.  Then again maybe not.  With the complete lack of liquidity that businesses have had over the past several months in the EU it is really surprising that the VDAX is back to pre-crisis levels. (Click on chart to enlarge)

German DAX VIX

What about other asset classes?  What are investors saying about potential risks?  Using the MOVE Index which measures the range in which Treasury yields are expected to move over the next 12-months we can see that even here investors are becoming increasingly complacent.  What happened to the runaway inflation that we keep hearing is right around the corner?  Right now the market is saying that we will be in a 130 basis point range for the next 12-months. In The Macro Trader weekly newsletter we are long the TLT 20+ Year Treasury ETF and are expecting a bigger move then is currently implied via the MOVE index. (Click on chart to enlarge)

MOVE Index

Even in the currency markets we are seeing extreme complacency.  Apparently investors the world over are back to selling dollars in exchange for anything.  While the USD has its issues other currencies do to.  Right now the currency markets are not participating in the Keynes beauty pageant where you are trying to pick the girl that you think the judges will think is the beautiful.  No, with the current state of the global economy we are in the least ugly pig contest where we are only trying to find the least ugly.  That being said investors do not appear to see a lot of volatility any time soon. (Click on chart to enlarge)

JPM G-7 VIX

Even the emerging market currency volatility index is showing complacency. What happened to the banking issues in Eastern Europe? Apparently they vanished, or at least that is what it seems as though the market is telling us.  (Click on chart to enlarge)

JPM Emerging Market FX VIX

Even commodities markets are pricing in realtively low risk. While the price history of the Crude Oil and Gold volatility indexes does not go back as far as we would like, you can get a feel for what is happening as both indexes are dropping at a very steady rate.  Do investors really think that volatility will stay that low?  What happened to the oil spike if demand comes back?  And what happens if gold breaks $1000 on fears of hyper inflation?  (Click on charts to enlarge)

Crude Oil VIX

Gold VIX

Another excellent tool to evaluate the blind risk taking happening right now in the stock market is the JunkDEX invented by Bill Luby over at VIX and More.  By taking an equal weighting of junk stocks AIG, FNM, C, CIT, and BAC you can see how crazy or composed investors are acting. While we have seen, and actually use, an index of high momentum stocks we had never thought of making an index that tracks junk stocks to gauge investors risk appetite.

As you can see in the chart of the JunkDEX below the junk led the market off the bottom and then lagged until the last month when the index shot up +157.36% in a little over a month.  While it has pulled back over the last two days we are still in awe that investors are dumb enough to buy this junk at these prices. (Click on chart to enlarge)

VIX and More JunkDEX* vs SP500

After looking at all of this we need to ask ourselves if the rewards outweigh the risk to stay long?  Or if we should be flat or short.  In case you have not guessed we currently think that the risk reward is pointing to the downside.

Looking at the QQQQ we have a setup with a solid risk to reward situation. As you can see in the chart below the QQQQ has rallied back to its 50% retracement level, its 200-week moving average, and its downtrend line extending from October 2007.  While it could of course rally higher we like the risk reward enough to have put on a modest short position in our weekly Macro Trader newsletter. (Click on chart to enlarge)

QQQQ-NASDAQ 100 ETF

While not quite as nice of a setup as the NASDAQ 100, the SP500 also looks like a solid risk reward trade to the short side.  As you can see in the chart below of the SPY-SP500 ETF it has rallied up to the upper Bollinger Band and has already started to come back in.  We are looking for a move back to at least the $95-96 area. (Click on chart to enlarge)

SPY SP500 ETF

Obviously anything can happen.  The market could go up every day for the next year, or it could go down every day, but our job as traders is to look for the best risk to reward scenarios that we can find and place trades on probable scenarios and right now we think the most likely scenario is for the market to at least have a pullback if not a correction back towards its 200-day moving average.  Of course if this happens we will see the volatility indexes tick upwards to more realistic levels given our current economic environment.

*Our JunkDEX differs a bit from the one you can see at VIX and More.  After looking into it we found that  we built the index by simulating a $1000 investment in the index and in the SPY and Bill built it by normalizing the index starting value so we have slightly different values.  But don’t worry as the chart looks essentially the same and shows the same investor insanity.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-In The Macro Trader newsletter as well as our accounts we are currently short some QQQQ-NASDAQ 100 ETF and long some TLT 20+ Year Treasury ETF.

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: Volatility Indexes, Risk Appetite, Mispriced Risk, And Where We Think We Are Headed
URL: http://www.themacrotrader.com/2009/09/02/mispriced-risk-macro-trader

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If you have been following port data you no doubt saw the large spike in March of both inbound and outbound volume, and then a bit of continuation in April and May.  A lot of people, both mainstream media as well as bloggers, came out saying that this was a huge green shoot and a sign that things were improving for the global economy.  The Macro Trader came out with this post (click here) where we explained that there is a lot of seasonal influence in shipping and without looking at it you are missing a huge part of the picture.

Looking at the data below is the chart for the month of March from 1995-2009 (click to enlarge).  As you can see March is a historically strong month, in fact it is historically the strongest month of the year.  So while we had a strong rebound in month to month data that was to be expected in March.  What many commentators forgot to mention was the year over year numbers which were anything but impressive, being down -17.21% that same month, not exactly the definition of a green shoot.

March Data

So where are we now?  Well after March we had slight increases in both April and May.  Historically April is the second best month of the year, so again not very unexpected.  In June we had a decline of -6.02%, and a year over year decline of -19.31% in total loaded volume. Looking at the chart below (click to enlarge) you can see that seasonality is easily seen in the data and that we are a ways off from a new move higher.

Combined Port of Long Beach and Los Angeles Data

We looked in the dictionary of overused terms and negative numbers were not under the term “Green Shoots”, however when we looked under weeds the exact definition was “negative numbers.”  OK, maybe that was a sad attempt at being funny but still the numbers are not pointing to a current increase in global shipping. To help smooth out the data and show the long term trend of shipping data here is a chart of total loaded along with a 12-month moving average (click to enlarge).  As you can see we are still in a downtrend and it will take more then a few months of increased activity to show real improvement.

Total Loaded with 12-Month SMA

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: Port Data, Green Shoot or Weed?
URL: http://www.themacrotrader.com/2009/07/19/port-data-green-shoot-or-a-weed/

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We decided that it was worth sharing our views of the inflation/deflation debate with all of our readers.  In our weekly newsletter we are already positioned to take advantage of some of the current as well as potential trends that will benefit from our scenario.

The following are our views on different parts of the puzzle that show that we are currently in, and will likely be experiencing deflation for longer then most people seem to think.

Savings-

Here are some interesting, and unfortunately not surprising, savings rate numbers.  The current savings rate is 5.7%, the all time high in 5/1/75 was 14.6%, the all time low was in 8/1/05 with a savings rate of -2.7%, the historical average is 6.8%, and the 10-Year average is 1.7%.  As you can see in the chart the past year has seen a huge uptick in the savings rate as consumers are trying to pay off debt and save some money.

Personal Saving Rate

Of course as savings go up spending goes down.  While this is good for the individual household it is a negative for the overall economy as it means less money is being spent on items from housing to cars to clothes.  While this could just be an abnormal blip in the scheme of things there are several reasons to think that this time the trend will hold for a while.

Baby boomers as a group don’t have anywhere near the funds to retire.  After 2008 wiped out 42% of the worlds wealth they should be scared and saving for their rapidly approaching retirements.  Once the economy starts to pick up they may very well start spending like it was 1999 again but we don’t think that they will because while most people are ok with the idea of working a bit past the age of 65, they do not plan on working into their 80′s and 90′s.

If the savings rate gets back up to the historical average of 6.8% or higher and then stays there for a while, it will be a huge drag on the economy. As consumers buy less and less, pricing will likely come down.  We are already seeing this in the form of huge sales in stores across the nation.  Many retailers have already had several markdown sales and it is safe to assume that this trend will continue for at least the next year or so.  If our projections are right and the savings rate gets back to “normal” we will likely see a re-pricing as most businesses just accept that fact that their profit margins will be smaller going forward.

Housing-

The monthly proclamations of a bottom by the NAR notwithstanding we have yet to see anything resembling a bottom in real estate. The Case Shiller 10-City index is down 33% from its peak and the 20-City index is down 32%.  Both charts look the same, which is to say each month is lower then the last month.  So far there has been no bottom.

Case Shiller 10-City Index

Not surprisingly housing sales numbers don’t look much better.  In spite of the monthly bottom calling we continue to see more new lows every few months.  As you can see in the chart below we are just off of new all time lows since the data series started in 1963.

SA Housing Sales

Zooming in a bit you can see that while we have had several blips over the last few years none of them have lasted for more then a few months and all have led to new lows. Our best guess is that we are headed lower in the next few months.

SA Housing Sales-A Closer Look

As if residential housing was not enough, the commercial real estate market is playing catch up.  Residential peaked in June 2006 and commercial held up until October of 2007.  Since October of last year however commercial has made a valiant effort to catch up and is now down -29.48% since then.  In fact from March to April alone it dropped -8.62%.  If real estate has found at bottom it is keeping its location secret because none of the data that we have seen points to it.

Moody’s REAL Commercial Property Price Index Composite(CPPI)

Of course you may be thinking that there has to be some commercial real estate that has found a bottom.  This may be the case on a geographic basis but it is definitely not the case when it comes to segments of the commercial market.  As you can see in the chart below industrial is the strongest part of the market and yet it is still down -14.26% from its highs.  Apartments are next being down -19.01%, followed by retail which is down -23.11%, and finally office space which is down a whopping -30.22%.  Judging by the massive drop this last quarter it is safe to assume that we have a ways to go before we really hit the bottom.

Moody’s REAL Commercial Property Price Indices

Employment-

In case you haven’t noticed employment has been horrible and getting worse.  One of the newest “in indicators” is the exhaustion rate.  While this indicator is not new it has luckily not garnered much attention over the years because it only gives a real signal once or twice a decade.  The exhaustion rate is the rate at which people come off, or exhaust, their unemployment benefits without having securing a job.  Why is this the “it indicator” right now?  Well if you look at the chart below you can see that we are not only at all time highs but are actually at 49.23%.  Yes, that means that almost half of the unemployed are done receiving unemployment money.  That of course leads to even less money to spend on anything.

Exhaustion Rate

After looking at the exhaustion rate chart it should come as now surprise that unemployment is high.  In fact it is at its second highest level ever at 9.4%.  As bad as unemployment is right now, it is going to get worse before it gets better.  We will likely hit at least 11% ,and we would not be surprised to see 12-14% unemployment before jobs data bottoms out.

Unemployment Rate

At this point it should not be much of a surprise but as you can see in the chart below, average weekly hours and non farm payrolls data are also both declining on a year over year basis.

Average Weekly Hours and Non Farm Payrolls

So how does all of this effect deflation?  If people are not working then they are not able to spend as much on consumer goods and services.  That includes clothing, food, entertainment, transportation, etc.  If they stay unemployed long enough and fall off of their unemployment benefits then they are able to spend even less.  Along with the lack of, or at least severely impaired, spending power there is a host of other side effects, which includes everything from defaulting on credit cards to defaulting on their mortgages.  As consumers spend less, businesses have to lay off more employees as sales drop off and margins are squeezed with exacerbates the situation.  One consistent relationship is that of the unemployment rate and capacity utilization.  As unemployment rises, capacity utilization drops as demand falls out.

Unemployment and Capacity Utilization (inverted)

If there is no demand then there is no spending.  If no one is spending then there can be no inflation.  If things are contracting then we are in deflation.  One more indicator that shows this is that of the output gap. The output gap is the difference between the amount that we can produce and the amount that we are currently producing.  In the chart below a positive number indicates under-utilization, and negative numbers reflect over-utilization.  If the line is rising things are getting worse and if it is declining things are improving.  As you can see the line has risen quite a bit and at least for now is showing no signs of turning around.  The output gap is a good indication of available demand.  As you can see. the output gap is bad and getting worse as demand continues to decline.

5-Year Output Gap

Banking-

While we could go on and on about banking we will try and keep it short.  Most people are pointing to the charts from the Fed on bank reserves and saying that they will cause hyper inflation.  Yes, the monetary base is at historic highs but guess what?  Until that money is actually in circulation it does not cause inflation.  You can print ten quadrillion dollars but if you bury it in a hole then it does not cause inflation.

Look at the chart below of the Adjusted Reserves.  As you can see it is at record high levels.  While it is extremely high it is not in circulation yet and likely will not make it to consumers for some time.

Adjusted Reserves

This number is extremely high due to all of the money that has been printed over the past year in response to the financial crisis.  But the inflationistas are missing one important point, namely that until banks have rebuilt their reserves they will not be lending.  As long as residential and commercial mortgage defaults continue banks will continue to rebuild their balance sheets.  Once they have a stable asset base they will start lending and we will likely see some really high inflation but until then we will be in a deflationary environment as the money is not being put into circulation.

Commodities-

Commodities are another reason that many use to justify their inflation arguments.  After having a good bull market from the end of 2002 until fall of 2007, they took off and got a bit parabolic for the first half of 2008 before crashing and coming back to levels not seen since 2002. Of course as anyone who has filled up their gas tank knows, commodities have started to climb once again moving from 200 up to 250 from the March lows.

Commodity Research Bureau Index

The rise has been widespread with energy, base metals, agriculturals, and even precious metals rising considerably.  Aside from precious metals it appears as though the primary reason that we had such a strong rebound was due to buying out of China.  In the first two quarters of the year the Chinese government decided to use some of their surplus to buy raw materials.  They bought a lot of copper, secured oil contracts, and stocked up on everything else.  Now it appears as though their buying is slowing to a trickle of what it was and with the run up in prices they are taking a break as they will likely get to buy more at lower levels.

While the buying out of China may help commodities put in a bottom, it does not appear as though it will drive them much higher.  With the possible exceptions of precious metals and energy we see most commodities turning in flat to slightly negative results for the rest of the year.  With the demand destruction that we have seen over the past year commodities have a tough road ahead of them before they will be able to climb higher.

Deflation-

So where does all this leave us?  Demand has been absolutely crushed on several fronts:  People are finally saving and paying down debt instead of spending.  Real estate is still falling, and with inventories as high as they are, will likely not fully recover for years.  Employment is as bad as at any time in the Post WW2 era.  Banks are still impaired and unable/scared to lend.  And with all this demand destruction commodities are unlikely to continue upwards for a while.

Finally there is the matter that while we can speculate on inflation we are currently in deflation as can be seen in the chart below of the CPI.  We have officially been in deflation for the last three months and while it might slowdown a bit we will likely stay in a deflationary environment for longer then most people think.

CPI-YoY % Change 1922-Now

What are we doing?

So if we believe that we are in deflation what do we do about it?  The best deflation trade that we have found is to be long bonds.  As we stated in our last blog post as well as the last few newsletter we are long TLT-20+ Year Treasury Bond ETF.  Not only are we in deflation but the trade was decent on its own merits.

Real yields on Treasury bonds at the end of May were at their highest levels since February 1995 and right now they are at 4.76% for the 10-Year and 5.58% for the 30-Year.  In an environment where we expect most assets to fall or go nowhere, we think that Treasury Bonds offer good value.

10-Year Treasury Bond Real Yield

Treasury bonds got almost as oversold recently as they were overbought back at the end of 2008.  By normalizing the trend using a 200-day moving average we build reversion to the mean charts that show how far above or below securities are from their mean.  In the case of the long bond our charts showed that it was extremely oversold and that it was a good time to start building a position.

TYX-30-Year Treasury Bond Yield Reversion to the Mean Chart

Looking at the chart of the TLT we could see it running up into the 100-105 range over the next month or two as investors take advantage of deflation, the oversold conditions, and the favorable real yield.

TLT 20+ Year Treasury ETF

While the long bond is definitely our favorite deflation trade, it also makes some sense to go long the US Dollar and/or the Japanese Yen as investors flock towards safety.  Other trades would be to short stocks and short commodities in anticipation of them falling as demand continues to decline and margins shrink.

And what about inflation?  We actually do believe that eventually all of this printed money will lead to some hefty inflation but right now we are in deflation.   Additionally the inflation trade is  the most overcrowded and one sided trade in the financial markets right now.  If we are right we will do well, and with the aid of risk management if we are wrong we will be stopped out for a small loss.

Happy Trading,

The Macro Trader

Dave@TheMacroTrader.com

Disclaimer-We currently hold positions in TLT

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: Deflation And What We Are Doing About It
URL: http://www.themacrotrader.com/2009/06/27/deflation-and-what-we-are-doing-about-it/

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For the first few months of the year West Texas Crude Oil was in an extreme contango situation.  In fact it got as high as 20% just four months out.  Looking at the 4-month contango/backwardization  in West Texas Crude Oil we can see that in just the past seven weeks it has dropped from over 15% to just 3.2%.

West Texas Crude 4-Month Contango/Backwardization

Most of the narrowing has happened in the near month futures, since over the past seven weeks the near month has rallied  27% and the 4th month only 14%.

Obviously the big question should be is demand really picking up? If so Oil should rise fairly quickly as we continue to see declining production as well as a decline in the ability to produce via the drop in rig counts over the last eight months.

Or is this a short term rise based on the notion that the economy is improving and this is just an extension of the risk trade?  If so then oil is to be shorted as are many other commodities as the reflation trade is put on hold.

We try not to fight the market and right now it is obviously in bull mode as it has moved up 75% from its lows.  That being said we tend to listen to the signals from economic indicators like capacity utilization, unemployment, and Fed minutes that show anything but an economic recovery.

West Texas Crude Oil

For now the trend is up and we are modestly bullish (that means we are flat) bulls.   However over the next few months we would not be surprised at all to be changing our view to the bear side and going short as the lack of demand likely overtakes these sorry excuses for green shoots and the economy, and therefore demand, roll over.

Happy Trading,

Dave@TheMacroTrader.com

Site Updates- Yesterday we installed Disqus to better  interact with our blog readers.  We welcome your views on energy, the economy, and any other financial topic.

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We were long precious metals coming into 2009 as gold, silver, and even platinum were climbing higher.  Eventually we got stopped out as the group consolidated for the next three months.  The last two weeks gold and silver have been able to breakout of the consolidation and is once again in an uptrend.  We went long in out model portfolio last week and are currently looking to add to our position if the trend continues.

GLD Gold ETF

SLV Silver ETF

In order to catch our trades in precious metals as well as other asset classes like stocks, bonds, currencies, and other commodities then sign up for a quarterly or annual subscription to The Macro Trader weekly newsletter with frequent intra-week updates.

Happy Trading,

Dave@TheMacroTrader.com

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In our newsletter this week we went long some UNG-Natural Gas and it is working out well.  The long term supply and demand characteristics were very favorable around the recent lows and we had a good technical picture as well.  As you can see in the chart below UNG has exploded to the upside on extremely high volume.  To put where natural gas is in perspective we also included a longer term chart showing the past 14 months.

UNG-Natural Gas ETF

UNG-Natural Gas Long Term Chart

Happy Trading,

Dave@TheMacroTrader.com

P.S. If you don’t want to miss out on more trades then subscribe to our weekly newsletter where we provide research on Domestic Equities, Foreign Equities, Fixed Income, Commodities, and  Currencies along with a model portfolio.  If you are interested in going beyond US stocks to generate returns in any market, we at The Macro Trader can help.

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Tuesday the Fed came out and said that they will not be expanding their quantitative easing operations.  They claim that things are looking good enough that they do not need to do more.  Of course we also had a really bad GDP number and long term rates have been climbing ever since the original announcement.  If the Fed is right and things are improving then we can expect to see some fairly strong inflation coming up in the next few months out to about two years.  Essentially at some point relatively soon we are going to be in a very inflationary environment.  Here are two sectors that we think will benefit from inflation, and will likely do well even if inflation is relatively flat.

MOO-Agribusiness ETF

OIH-Oil Service HOLDR

Happy Trading,

Dave@TheMacroTrader.com

P.S. If you are getting value out of our posts, you can do us a favor by linking to us with your site or blog and mentioning The Macro Trader to any of your friends that trade.

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One of the best indicators to see how the global economy is doing is to just look at the CRB index.  While we don’t expect it to be hitting new highs anytime soon, it would be nice to see it moving up at least a little.  Instead as you can see in the chart below it has only managed to find some type of bottom.  If it’s “The Bottom” or just “A Bottom” is besides the point for now.  It is enough to see that it is not trending up.

CRB Index

Another good indicator to look at to gauge the strength of the global economy is that of the Baltic Dry Index.  Over the last couple of weeks we have seen many blogs and other market commentators mention that the index has been climbing.  Of course what they fail to mention is that if you look at the longer term chart of the index, it is still down significantly and it makes the recent rally look insignificant.

Baltic Dry Index-Short Term

Baltic Dry Index-Long Term

Needless to say we think that many commentators are getting ahead of themselves in saying that the economy has bottomed.  In fact the vast majority of the economic indicators that we follow are still pointing straight down, without any “green shoots” characteristics.  Until we can get some  historically reliable indicators pointing to a bottom and/or a rebound we will be cautious as capital preservation is our first priority.

Happy Trading,

Dave@TheMacroTrader.com

P.S. If you are getting value out of our posts, you can do us a favor by linking to us with your site or blog and mentioning The Macro Trader to any of your friends that trade.

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Following up yesterdays post regarding what we see happening in the crude oil market we were happy to see the inventory numbers come out this morning and once again confirm what we have been seeing, namely that until Contango narrow significantly or goes away entirely there will be a large incentive for large energy traders to buy oil in the cash market and sell a forward contract to lock in a gain.

With Contango at 10% from the current month out to August there is a huge incentive for large speculators like global macro and energy funds as well as oil companies that have extra storage capacity to put this trade on and just sit on the oil until it has to be delivered.

Here is a chart of oil inventory data and as you can see we are at highs not seen since 1990.

Weekly US Crude Inventory

Happy Trading,

Dave@TheMacroTrader.com

P.S. If you are getting value out of our posts, you can do us a favor by linking to us with your site or blog and mentioning The Macro Trader to any of your friends that trade.

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In our subscriber letter this week one of the topics that we discussed was the production destruction as seen in the rig count data provided by BHI-Baker Hughes. They provide weekly oil rig data for the United States and Canada and Monthly numbers for international data.

So what do the numbers show? Well in the United States and Canada the rig count has come down 57% from the highs seen in 9/1/08.  This has taken the rig count back to the levels seen in 2002.

US and Canada Rig Count

Internationally the situation is not quite as bad, but it is still bad.  Rig counts worldwide have dropped off 35% and we are back to levels not seen since 2004.

International Rig Count Data

After looking at these charts it would seem logical to say that oil is going up as production levels are down so much.  Long term this is probably right but in the short and even medium term there are a few major issues that have to be dealt with before oil can have another large bull run.

The main problem is what is referred to as the output gap.  The output gap basically says that there is a gap between what we are producing and what we are able to produce.  While a small gap almost always is existent right now it is very large.  Until the economy actually starts to pick up some steam this gap will remain wide.  As the economy produces less and less the need for commodities continues to decline.

This drop in demand for commodities has started to slow but it is still dropping.  As we showed a few days ago in our post on port data, world shipping data and therefore world trade has dropped off a cliff.

LA and Long Beach Port Data

Until indicators like the Baltic Dry Index and port data start to turn up, oil and other commodities will have a hard time climbing back anywhere near $100 a barrel let alone the $150 we saw almost a year ago.

Another thing that continues to put pressure on oil is the extreme contango that we have seen this year.  Contango in the futures market is when the near month contract is selling at a discount to the farther out contracts.

While a bit of contango is not unusal we have had some extreme readings this year.  In fact at one point you could have bought oil in the cash market and by selling the contract six months out you would have locked in a 25% return minus the storage costs.

Over the past few months however the spread has narrowed but is still high enough to cause speculators to build up supply until it is time to deliver.  Right now contango is at 10% from the June to September.  This means that you could be buying oil now and lock in a 10% return.  Until the premium is brought down closer to storage costs there will be a lot of artificial demand which depresses prices and makes it hard for oil to go up in a big way.

4-Month Contango Curve

So until demand picks up and contango comes down we will likely not see a large sustained move up in oil.  That being said there are and will be many trading opportunities to the long and short side, but we feel as though a long term bull move is still a ways off.

Happy Trading,

The Macro Trader

Dave@TheMacroTrader.com

P.S. If you are getting value out of our posts, you can do us a favor by linking to us with your site or blog and mentioning The Macro Trader to any of your friends that trade.

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