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Chart In Focus

Crude Oil Abnormally Quiet

Chart In Focus
June 19, 2014

The news stories about crude oil in the financial media have been all about how oil prices have been volatile based on the crisis in Ukraine, the crisis in Iraq, the crisis in Nigeria, the lack of a Keystone pipeline, etc.  But what has been underreported is that there has actually been hardly any volatility at all.

This week's chart features an indicator looking back over the past 4 months' closing prices for  crude oil futures, and measuring the spread between the highest and lowest closes over that period.  That spread is then expressed as a percentage of the average closing price over that same four month period. 

The remarkable point is that even with all of the geopolitical crises around the world, this indicator just posted its lowest reading in more than 20 years.  That's right, oil is at its quietest point in decades, at the same time when world oil supplies are supposedly under threat. 

Quietness of prices is not much fun for the financial media to report about, which is why you probably have not seen mention of this point elsewhere.  But aside from the interesting historical tidbit about it being the quietest 4-month stretch for prices in decades, we should look for the "so what" of this low reading.

There are many other indicators that technical analysts use to measure volatility, including the Choppiness Index, Bollinger Bandwidth, standard deviation, and others.  The universal idea behind the use of all of them is that when you see a quiet, non-trending period, the expectation is that it should be followed by a more active trending period.  And  that principle seems to work with this indicator as well, with these 4-month low percentage range readings regularly leading to a trending move.  But it does not tell us in which direction that trending move is likely to go. 

One hint of that answer for the current situation comes from this next chart, which reveals that there is big disagreement among the different oil futures contracts across the maturity spectrum.  The near month contract, which is currently the July 2014 contract, is priced at $106/barrel.  But if we go out to the June 2015 contract, it is $9 lower.

Crude Oil Backwardation and Contango

That is a condition known as "backwardation", which is the opposite of the supposedly normal condition known as "contango".  Backwardation arises when there is nervousness about near term supplies, but at the same time the market players believe that prices for later delivery deserve to be lower.  When backwardation arises like this in crude oil, what follows is a big price decline.  But that decline can be delayed for several months before it finally does arrive. 

So now we have a condition where the potential energy of the backwardation condition says prices should head downward, and we have a very low volatility condition which suggests that a trending move should unfold in some direction.  My conclusion is that a big down move is coming for oil prices.  We just need to have peace break out somewhere to make that happen. 

Tom McClellan
Editor, The McClellan Market Report

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