On August 10, we downgraded our outlook on WTI from neutral to bearish thanks to a significant deterioration of the trend. We determine trends for a number of major currencies and commodities based on price, trading volumes and changes in volatility. Following WTI’s latest top at $75.37/barrel, sell-offs in the commodity have been accompanied by accelerating trading volumes. This is a bearish sign that suggests that traders are selling crude oil with conviction. The trend in underlying volatility (based on the CBOE crude oil volatility index) also suggests increasing volatility in the foreseeable future.
Since that time, the commodity has fallen by about 4% based on crude oil futures traded on the NYMEX. Beyond a bearish quantitative trend, we expect (1) weakening fundamental dynamics, (2) peaking US growth, and (3) a significant speculator long position to weigh on crude oil prices going forward.
Crude oil fundamentals now foreshadowing a downturn
In recent history, major turning points in crude oil prices have coincided with changes in supply versus demand growth. This is visually represented below. Note that year-over-year changes have been smoothed out by using a 3-month moving average.
YoY supply growth vs. YoY demand growth: past the flip
Source: US Energy Information Administration, MarketsNow
As can be seen above, changes in demand growth versus supply growth have accurately foreshadowed long-term tops and bottoms in the crude oil market. Crude oil prices began a bottoming process in late 2015, once demand growth overtook supply growth.
In the second quarter of this year, supply growth has once again overtaken demand growth. Unsurprisingly, the commodity began a topping process shortly thereafter, reaching its most recent highs in late May and early July 2018.
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