Op/Ed

Trading Desk Notes For February 26, 2022

The Russian Blitzkrieg invasion of Ukraine initiated DRAMATIC surges and reversals across markets

The S+P plunged to a 9-month low early Thursday morning (down ~15% from January All-Time Highs) but then rallied hard into Friday’s close.

The DJI tumbled and bounced back ~1,700 points in this 4-day week to close almost precisely where it closed last week! (Like nothing happened!)

Gold had been trending higher (up ~ $125) since late January but soared another ~$75 early Thursday, only to plunge nearly $100 later the same day.

Gold is leaving Bitcoin in the dust.

WTI crude oil rallied ~50% from early December to mid-February – it soared and collapsed ~$9 on Thursday (after briefly trading above $100 for the first time in eight years.)

Chicago wheat soared to a 12-year high and then tumbled sharply on Friday (soybeans and corn also surged and fell this week.)

The US Dollar Index surged to a new 20-month high (as the Euro plunged to a 20-month low), then fell sharply into Friday’s close.

The Russian Ruble tumbled to a new All-Time Low Vs. the US Dollar.

Stock index options volatility soared to nearly the highest levels since the Covid panic in 2020 but fell sharply on Friday.

This chart is from Thursday:

Why the stunning market reversals this week?

Markets were shocked at the Russian attack’s speed, size, and ferociousness. Everybody knew the Russians had massed troops and military hardware to the North, South and East of Ukraine, and the “geopolitical stress” had exacerbated risk-off sentiment last week, especially with American and British intelligence services predicting an imminent attack.

this chart was released mid-week:

But “nothing” happened in Ukraine early in the week, and then, suddenly, Wednesday evening, the Russians charged. Markets did what you’d expect: stocks fell, the US Dollar, gold, commodities and volatility soared.

Stocks gapped lower when Thursday’s day session began – but Big Tech began to rally immediately while the broader market went sideways to lower.

On Thursday’s gap lower opening MSFT was down >20% from its November high. AAPL was down >16% from its January high. GOOG was down ~18% in less than a month. AMZN was down ~26% from its November highs. TSLA was down >40% from its early January highs, and NVDA was down ~38% from its November highs. FB was down>40% in less than a month.

Somebody started buying Big Teck with both hands when the market opened sharply lower Thursday morning. It was probably hedge funds covering shorts, which sparked the monster rally.

Market liquidity was thin – a war had just started – and option volatility had soared. As Big Tech started to rally, options dealers turned buyers to manage gamma risk – and as markets continued to rally, people who had previously bought puts began selling them, adding fuel to the fire.

When market sentiment becomes extremely risk-off (like when a war starts), correlations between assets go to one. With Big Tech leading the stock markets higher (the Nasdaq 100 was HUGELY out-performing the Dow), people started selling the spike rallies in gold, crude, grains and the US Dollar. People who had bought those markets (thinking they would have massive rallies because of the war) were positioned wrong and had to sell, accelerating the reversals from the spike highs.

One of the characteristics of bear markets is that they have face-ripping “bear market rallies,” – which we saw on Thursday and Friday. (One of the great market chestnuts is that everybody loses money in a bear market.)

It is critical to understand that the rally was NOT caused by people assuming that the war in Ukraine was “no big deal.” The war may end this weekend – or it may continue for months – but it is still a huge deal even if it does end this weekend. Putin has taken the gloves off, and a new cold war has started, which will have a HUGE impact on markets.

Russia is now a severe problem. Russia is not monolithic, and Russia is NOT Putin – who has been exposed as a cold-hearted liar. Thousands of Russian citizens have been arrested for protesting the war. The speed of the attack may have made Russia appear invincible, which may be far from the truth. The assumption that Putin will have unwavering support from China may also be wrong. (Wouldn’t it be interesting if Xi turned his back on Putin the Pariah?)

Russia will be isolated and will likely retaliate against the sanctions. Think cyber-attacks against the West. Commodity exports from Russia will be reduced – buyers will have to source products from other commodity-producing countries.

Western governments may be shocked into abandoning virtue-signalling ESG driven energy policies and start encouraging the development of reliable energy supplies. The USA, for instance, may promote the development of domestic fossil fuels and Canadian oil sands. (Note: CNQ closed at All-Time Highs Friday – despite WTI closing $9 below Thursday’s high.)

Biden has the State of the Union address on March 1, and this will be his opportunity to turn around his and the Democratic party’s fading popularity.

My short term trading

I got off to a slow start this week after the 3-day President’s Day weekend. I was flat at the end of last week and in no hurry to find a trade just for the sake of “doing something.”

I bought the S+P Tuesday and closed the trade for a small gain. I bought the Dow futures Wednesday and closed the trade for a slight loss.

I bought the S+P early Thursday morning as the market rallied back from the overnight lows but was stopped for a small gain. I rebought it a few minutes later as the market recovered from a brief setback and covered it on the close for a 110 point gain. I thought that the rally was a bear market short squeeze, and 110 points was a great move. The market rallied another 100+ points Friday without me.

The S+P rallied almost 300 points from early Thursday morning to Friday’s close. To put that stunning move into perspective: since the market turned up from the Covid panic lows in March 2020, there have only been three entire weeks with a 300 point high/low range.

I was flat going into the weekend, and my P+L was up ~1.2% on the week.

On my radar

The spectacular commodity rally that saw the indices gain >200% since the March 2020 lows may have made an important top this week. The same thinking may apply to crude oil. I’m not saying the BIG commodity rally is over, but a correction is overdue.

I think the stock market rally off this week’s lows is a bear market rally, and it will run out of steam and rollover.

My son Drew points out that oil bulls might consider writing December ATM puts. Dec closed Friday at ~$81, an $11 discount to front-month April. The Dec $81 strike puts trade at around $11. Net/net if you sell the puts and get exercised at the end of November, you will effectively be long WTI at ~$70, which is ~$22 below the current front month price of $92. Backwardation creates opportunities. (This is not investment advice. Remember, WTI dropped from $147 in July 2008 to $33 in December.)

If WTI and commodities have the correction I expect, and then steady, I will look at writing forward dated WTI puts.

Thoughts on trading

This week was a great week for “making peace” with the fact that I can’t catch every move. I wanted to sell gold up $80 Thursday morning, and I wanted to sell WTI at $100. But I already had “the trade” on by being long the S+P. I noted above that correlation goes to one when sentiment is extreme. In that sense, in this environment, being long S+P was the “same thing” as being short gold or WTI. If I made the gold or WTI trade, I would be “concentrating” my risk exposure – and that’s great if you’re right, deadly if you’re wrong.

Of course, you can never have enough on when the market is soaring in your favour!

I’ve noticed my trading time horizon has shrunk as short-term price ranges have increased, which is purely intuitive risk management. I never used to be a day trader – but with today’s intra-day price swings more significant than what we used to see in a week or a month – well, it seems we’re all day traders now!

Quotes from the notebook

“Old school media want your top picks – they don’t care about or want to hear about your process.” Kieth McCullough – Hedgeye, RTV interview 2019

“Commentator’s (ie, chief strategists) success is linked to how often they are right or wrong. (They don’t have a P+L.) They are therefore entertainers…their fame is the result of their presentation skills.” Nasim Taleb – Fooled By Randomness

“I keep an eye on “the news” and “commentary” to get an idea of “positioning.” I want to have some idea of how much mispricing will be exposed if markets move contrary to the “commentary.” I want to front-run that re-positioning.”

Victor Adair, notes to myself, 2019

The Barney report

The Barns and I have been home alone for a few days this week as Moma is in the Big City helping friends. I make a point of getting him out for at least two long walks every day. This week he discovered Papa’s reading chair as a good place to rest up after a long walk. His claws are leaving marks on the leather – but what can you do – it’s the perfect place for him!

A Request

If you like reading the Trading Desk Notes, please forward a copy or a link to a friend. Also, I genuinely welcome your comments, and please let me know if you would like to see something new in the TD Notes.

Listen to Victor talk markets on a podcast

I’ve had a regular weekly spot on Mike Campbell’s extremely popular Moneytalks show for 20 years. The February 26 edition is available at: https://mikesmoneytalks.ca.

Victor Adair retired from the Canadian brokerage business in 2020 after 44 years and is no longer licensed to provide investment advice. Nothing on this website is investment advice for anyone about anything.

Schachter’s Eye on Energy for February 24

Each week Josef Schachter gives you his insights into global events, price forecasts and the fundamentals of the energy sector. Josef offers a twice monthly Black Gold newsletter covering the general energy market and 30 energy, energy service and pipeline & infrastructure companies with regular updates. We also hold quarterly webinars and provide Action BUY and SELL Alerts for paid subscribers. Learn more.

We are in a dire moment in history. Russia has invaded Ukraine and the war premium for crude has risen sharply. WTI today rose over US$100/b. How high crude prices go in the near term depends upon the severity of sanctions that will be imposed in the coming days. The key is what will Germany accept as they are the largest importer of energy from Russia. If energy, metals and grain exports by Russia are impacted by sanctions then all three of these product groups will have further significant upside price moves. Crude in this situation could rise over US$120/b in the short term. If only sanctions on Putin and those close to him are implemented and Russia is removed from the SWIFT financial clearing system, then crude will not skyrocket much higher. Today’s sanctions relate to use of outside currencies to purchase Russian goods. Also exports like technology are now not allowed which should hurt the Russian economy. They did not remove them from the SWIFT financial system as Europe still needs to pay for imports from Russia. These increased sanctions will be challenging for Russia but not severe enough to change Putin’s naked aggression. The next two weeks are the window of uncertainty as we see what Russia’s plans for Ukraine and its neighbors are. While these sanctions are tough, China has agreed to support Russia through these more difficult economic times.

EIA Weekly Oil Data: The EIA data of Thursday February 24th was moderately bearish for energy prices but the price of WTI and Brent crude are reacting to the Russian invasion of Ukraine and the possibility of energy export sanctions against Russia. Russia provides Europe with 25% of its crude and products and over 40% of its natural gas needs.

US Commercial Crude Stocks rose 4.5Mb versus the forecast of a rise of only 0.4Mb. The main reason for this difference is that Net Imports rose 623Kb or by 4.3Mb on the week. Motor Gasoline Inventories fell 0.6Mb while Distillate Fuel Oil Inventories fell 0.6Mb. Refinery Utilization rose 2.1 points to 87.4% from 85.3% a week ago. US Crude Production remained steady at 11.6Mb.

Total Demand fell 1.26Mb/d to 21.5Mb/d as Other Oils demand fell by 874Kb/d to 4.93Mb. Motor Gasoline rose 87Kb/d to 8.66Mb/d. Jet Fuel Consumption fell 30Kb/d to 1.48Mb/d. Cushing Crude Inventories fell 2.0Mb to 23.8Mb.

EIA Weekly Natural Gas Data: Weekly withdrawals remain high as winter continues. Last week’s data showed a withdrawal of 129 Bcf, lowering storage to 1.782 Tcf. The biggest US draws were in the Midwest (46 Bcf) and the East (39 Bcf) and in South Central (34 Bcf).

The five-year average for last week was a withdrawal of 163 Bcf and in 2021 was a whopping 338 Bcf due to the severe weather that week. Storage is now 10.7% below the five-year average of 1.996 Tcf. Today NYMEX is US$4.70/mcf due to an expected colder spell in the coming days. AECO is trading at $4.46/mcf. After winter is over natural gas prices typically retreat and if the general stock market decline unfolds as we expect, a great buying window should develop at much lower levels for natural gas stocks in Q3/22.

Baker Hughes Rig Data: The data for the week ending February 18th showed the US rig count rose by 10 rigs (up 22 rigs in the prior week) to 645 rigs last week. Of the total rigs working last week, 520 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 60% from 397 rigs working a year ago. The US oil rig count is up 71% from 305 rigs last year at this time. The natural gas rig count is up a more modest 36% from last year’s 91 rigs, now at 124 rigs. Texas had the largest increase in rigs with 8 added last week and the total rising to 308 rigs. The Permian (Texas and New Mexico) added five rigs taking the total rigs working in this lucrative basin to 306 rigs.

Canada had an increase of one rig (up one rig last week as well) to 220 rigs. Canadian activity is up 28% from 176 rigs last year. There was a two rigs decline for oil rigs and the count is now 135 oil rigs working up from 100 last year. There are 85 rigs working on natural gas projects now, up from 72 rigs working last year. Staffing of rigs in Canada is becoming a problematic issue and adding significant more rigs in the near term is unlikely. While day rates are rising, so are costs and therefore margin improvements are not what one should expect as the industry activity picks up. The current view is that margins should rise after spring breakup.

The overall increase in rig activity from a year ago in both the US and Canada should translate into rising liquids and natural gas volumes over the coming months. The data from many companies’ plans for 2022 support this rising production profile expectation. We expect to see US crude oil production reaching 12.0Mb/d in the coming months. Companies are taking advantage of attractive drilling and completion costs and want to lock up experienced rigs, frack units and their crews as staffing issues are difficult for the sector. The EIA forecasts US production reaching 12.5Mb/d before the end of this year.

Conclusion:

Bearish pressure on crude prices:

1. The Omicron pandemic is far from over but is losing its impact as individuals have been vaccinated and reopenings occur with no mask requirements. Covid-19 deaths are rising for the unvaccinated. Deaths in the US have reached 936K (up 14K over the last week) and worldwide has reached 5.89M.
2. The Iran nuclear negotiations are working towards sealing a deal and having sanctions removed so that they can sell their oil around the world. Negotiations appear to be making a breakthrough with a timeline of next week. President Biden may be giving away more concessions to Iran in order to have sanctioned Iranian oil available if Russia is precluded from sales to Europe and the US. If a deal is concluded in the next week or so and Iran receives sanction relief, Iran could increase production by over 1.5Mb/d immediately. Iran also has over 200Mb in storage around the world near its buyers, so those volumes could be added to supplies quite quickly.

Bullish pressure on crude prices:

1. Russia has invaded Ukraine and this is likely going to continue for a few weeks to complete their objectives. The US sees Russia having 200K troops in their invasion force. Cyber and air attacks since the invasion launch on Wednesday February 23rd have been happening throughout the country. The land battle has started with the invasion forces landing at the Black Sea ports and land forces coming in from the east and the north.
Russia provides over 26% of western Europe’s crude oil and product needs and over 40% of its natural gas needs. Any sanctions on these sales would not be easily met by other producers. This effectively is a two-edged sword. The US is sending over more cargoes of LNG and has asked Qatar and other producers to do the same. What new sanctions are agreed to with European countries will be key to how high crude prices go in the near term. If Russia is not allowed to export to Europe, then the shortage will be difficult to meet even with Iran being allowed to sell again to the world. Germany is the key to what occurs as they are the most reliant on Russia. WTI crude has lifted to over US$100/b today and may go up much more in the short term if Russia loses access to western markets. In the end though Russia will find a buyer for its energy volumes from China, so the issue will be logistics to make this happen.

The cost of this war is significant for Russia but the rise in prices of energy, metals and grains has been so large that this may be a financial boon for Russia. Crazy!

CONCLUSION:

The invasion of Ukraine has spiked up crude prices. WTI rose today to over US$100/b and has reversed to $92 with the sanction announcement. If financial access to the ‘SWIFT’ clearing system is added later then crude could spike upward again. If Russia is precluded from selling energy and other products to Europe then crude could spike to over US$120/b in the near term. So far this has not happened. Today’s sanctions will hurt but will not change Russia’s course of action.

In the end the higher energy prices will knock down demand and we are likely to see recessions around the world later this year. If this unfolds then demand could fall 3-5Mb/d and the price of crude will fall from its current war premium, elevated level.

Energy Stock Market: The stock markets around the world are getting hit hard as the concerns about the extent of the war and its implications spook markets. The Dow, the S&P, the Nasdaq, the TSX and other world exchanges (Germany has been hit by 5% earlier today) have broken support levels and look to have significant further downside. The bubble has burst already for the MEME and FAANG US stocks and now the overall market bubble has been pricked. Today even with all the bullish price action in crude the S&P/TSX Energy Index is down on the day and currently trades at 197 (down seven points from last week).

Our February SER Monthly Report comes out tomorrow and covers the latest signs of deterioration in the general stock market and increased weakness in key world economies. Significant stock market downside is ahead and investors should be defensively prepared. Some of you may remember the market upheaval of other bear markets like in 1987, 2000, 2008, and 2020? We hope you have prepared yourselves for this impairment risk to your assets. We have had six significant down days for the Dow Jones Industrials this month and much greater daily declines are likely in the weeks ahead.

Our February SER report covers this painful market situation. The Q4/21 and year end results for 2021 are starting to be released for the 30 companies that we cover. In next week’s issue we cover four companies that have reported by the close on Friday February 18th. In the March issues we will cover the rest of the regular reporting run.

Our Q1/22 quarterly SER webinar will be held tonight Thursday February 24th at 7PM MT. If you want to join/register for this event or access our Interim Report or the upcoming SER Monthly become a subscriber. Go to https://bit.ly/34iKcRt to subscribe.

Please feel free to forward our weekly ‘Eye on Energy’ to friends and colleagues. We always welcome new subscribers to our complimentary energy overview newsletter.

Trading Desk Notes For February 19, 2022

Interest rates have steadied after surging higher since November

The Dec 2022 Eurodollar futures contract closed red for 11 consecutive weeks but finally closed green this week as the relentless surge in short-term interest rates took a breather. (Eurodollar futures trade at a discount to par, or zero, so a price of 98 = a 2% interest rate.)

The US T-Note futures contract closed green this week with the 10-year yielding ~1.93%, down from last week’s high of ~2.05%.

Mortgage rates have increased sharply as bond yields have spiked.

One of the reasons mortgage rates have been rising, other than interest rates spiking, is that demand for mortgages is WAY up.

Interest rates for bank deposits haven’t increased much, but if/when they do, it will be interesting to see if people stop “reaching for yield” the way they have been.

The global supply of negative-yielding debt keeps shrinking as interest rates rise.

Stock markets were under pressure again this week

The DJIA, the S+P and the (much broader) Vanguard Total Stock Market ETF had their lowest weekly close in over six months.

Classic 60/40 portfolios are not doing well YTD, with both stocks and bonds down.

With stocks down, interest rates rising, inflation and geopolitical tensions, it’s no wonder bulls are pulling in their horns.

Here’s what Fund Managers worry about:

WTI crude oil futures steadied this week after rising 9 of the 10 previous weeks, up >50% from December lows

Geopolitical risk is giving energy markets a lift. Still, the BIG story is that rising global demand is gobbling up supply while spare production capacity shrinks thanks to chronic underinvestment in developing new reserves. And then there’s the ESG factor.

The “geopolitical risk premium” in crude oil markets has driven the time spreads to historical wides.

Gold and gold shares have been smoking hot on inflation and especially geopolitical concerns

I’ve read every weekly issue of the GOLD MONITOR, published by my friend Martin Mureenbeeld, since 1992. Gold producers and institutional investors around the world subscribe to his service. If you are seriously interested in gold you can sign up for a free trial on his website.

In this week’s letter Martin notes that, “gold has clearly broken away from the dollar and interest rate factors, confirming that the overriding determinant of gold just now is geopolitical. The Russia/Ukraine crisis may have added some $100 to the price of gold to date. This will be much larger in the event Putin chooses to invade (a typical rise translates into $180 today!) Gold will sell off quickly in the event Putin backs off.”

Gold shares have underperformed bullion for months but have jumped relative to the S&P this month.

The US Dollar Index has been broadly sideways since November – but closed green this week – Russia/Ukraine

The USDX hit an 18-month high in January but couldn’t sustain those gains.

The Canadian Dollar started to rally with WTI from the December lows but ran out of gas. Perhaps the risk-off tone in American equity markets put a damper on the CAD.

FOR THREE WEEKS, the CAD stayed in a narrow range between 7825 and 7900. The CAD has not reacted to the draconian Emergency Measures Act instituted by the Federal government this week. I’m assuming the market thinks this policy will be very narrowly focused and will quickly “blow over.” However, suppose that is not the case. In that event, I expect to see capital flight from Canada to the USA (which will be seen as the “Switzerland” of North America by worried Canadians) and substantially less Foreign Direct Investment in Canada.

You have to wonder if the boy wonder did a cost/benefit analysis before he made his draconian announcement. Not likely.

The following is my Valentine’s Day Tweet following the announcement of the Emergency Measures Act:

I’ve been a huge Mordecai Richler fan for decades. I’ve read “Barney’s Version” six times and watched the movie several times. (Yes, I named my dog after Barney.) If Mordecai were alive today, he would be ripping into the Federal Government with a venomous pen. Nobody could do it better!

Busybodies

Several years ago, when I was hosting the Moneytalks radio show, I referenced an article I’d read in the newspaper which quoted a person described as an “activist.” This person was determined that people agree with her vision of how the world “should” be.

I explained to my listeners that anytime I read an article that cites an “activist,” I automatically substituted the word “busybody.” My grandmother used the word “busybody” to describe people who thought they knew best about how other people should spend their time and money.

When covid came along, I realized it would be a busybody’s wet dream. They would feel morally justified shrieking at other people about how they should behave.

It turned out to be way worse than I imagined. The busybodies were everywhere and lusted for the authority to enforce their views. Many of the busybodies held elected office and did what they could to make other people do what they thought was best.

No wonder we’re seeing a magnificent decline in people’s respect for (or confidence in) government. This loss of confidence will change the world as we know it; the trading opportunities will be extraordinary!

My short term trading

I started this week short S+P futures from last week. I had stayed short over the weekend because the market had been down hard Thursday and Friday, and I thought it would likely fall further this week.

The market was lower in the Sunday overnight session but rallied ahead of the Monday day session, so I covered my position for a gain of ~85 bps.

I bought the S+P Tuesday but was stopped for a slight loss (and missed the Tuesday overnight rally.) I shorted the market Wednesday but was stopped for another slight loss (and missed the big Thursday/Friday drop.)

As you can imagine, I was mumbling to myself about having my stops too tight in a choppy market. But at the end of the week, I was flat, and my P+L was up ~0.55% for the week.

I looked hard at buying bonds and shorting stocks Friday. I didn’t make either trade because they were FOMO motivated, and I didn’t have a good setup. I would have been “making a bet” on things getting worse in Ukraine over the long weekend (once the Olympics were over.)

I cannot handicap the existential Ukraine crisis. If it gets worse, stocks will probably fall, and bonds will likely rally (as will gold.) But protecting my capital by not “making a bet” was the right thing to do.

Quotes from the notebook

“A good deal of selling takes place because people like the fact that their assets show gains, and they’re afraid the profits will go away.” Howard Marks, in his Selling Out Memo, January 2022

My Comment: I’m a big Howard Marks fan; I read his book, The Most Important Thing – Illuminated, twice. You might think it odd that a short-term futures trader would take an interest in a value investor who holds positions for years. Still, he is a hugely successful investor with 50 years of experience – and I like his way of looking at markets and people’s behaviour. I’ve read his monthly memos for years. I recommend him to you.

“There is tons of talk (about) how Central Banks have lost control of inflation expectations – nothing could be further from the truth. Markets still have complete confidence that Central Bankers will control inflation in the coming quarters.”

“So far, the market believes we have experienced a cyclical inflationary upswing within a secular dis-inflationary environment. At some point, market participants will realize that we are not going back to the post-Volcker-pre-COVID world. When that happens, the repricing of assets will be fierce and brutal.”

“Watch for this shift. It will likely prove to be the inflection point for a whole new investing environment.” Kevin Muir, THE NEXT INFLATIONARY INFLECTION POINT The Macrotourist February 2022

My Comment: I lifted this quote from Kevin’s latest piece on his Macrotourist subscription service. I read ALL of his pre-subscription essays over four years and became a paid subscriber when he went behind a paywall two years ago. His service is worth every penny. I highly recommend him to you.

If I could paraphrase his message, it would be: The market expects the Fed to tighten (bonds, for instance, are NOT in free-fall because the market expects that Fed tightening will rein in inflation) but eventually, the Fed will “waffle” (will NOT keep tightening when they should) and then long-term higher inflation expectations will (really) kick into gear – and we will enter a whole new investing environment.

The Barney report

The “Golden Boy” has Papa wrapped around his (not so little) paw. I love taking him places to “run wild” and have a great time. When we come home, he laps up a bowl of water and falls dead asleep. This is the look I get when he thinks it’s time for me to take him for another long walk.

A Request

If you like reading the Trading Desk Notes, please forward a copy or a link to a friend. Also, I genuinely welcome your comments, and please let me know if you would like to see something new in the TD Notes.

Listen to Victor talk markets on podcasts

I’ve had a regular weekly spot on Mike Campbell’s extremely popular Moneytalks show for the last 15 years. The February 19 edition is available at: https://mikesmoneytalks.ca

I also recorded a 30 minute (This Week In Money) podcast on February 18 with my good friends at Howestreet.com.

Victor Adair retired from the Canadian brokerage business in 2020 after 44 years and is no longer licensed to provide investment advice. Nothing on this website is investment advice for anyone about anything.

Trading Desk Notes For February 12, 2022

Interest rates rocket higher

Interest rates have been climbing steadily since early December but rocketed higher this week on the one-two punch of surging CPI and a call from St. Louis Fed President Bullard for the Fed to “immediately” take aggressive hawkish action.

Last week I noted the dramatic “rate of change” in European interest rates when Christine Lagarde surprised the market by opening the door to the ECB raising rates this year. This week the “rate of change” in American short rates was equally dramatic. On Thursday, Eurodollar futures (first chart above – trade at a discount to par) suffered their largest daily drop in over ten years. Ten-year US Treasury yields traded above 2% for the first time in nearly three years.

The 10-Year Greek yield rose from 0.55% last summer to 2.63% (Purple line below), while the 10-Year UST rallied from 1.2% to 2.05%. (Gold line.) When interest rates were historically low last summer, weaker credits could borrow “cheap” relative to quality credits. As interest rates have risen, the spreads have “gone out.” This is true for sovereign borrowers as well as corporate. (If you wondered why Greece could borrow at rates substantially below the rates the USA paid, take a bow in the direction of the magnificent ECB bond-buying program.)

(The “rate of change” – the delta – feeds on itself as people (option sellers, for instance) who were unprepared for the speed and magnitude of the recent move capitulate and liquidate their positions, adding weight to the chain of falling dominos.)

Another “rate of change” to consider is the Fed changing from buying bonds (QE) to selling bonds (QT). The chart below was created on Wednesday. As of Friday, the switch from QE to QT looks more like May than August. (Maybe earlier if Bullard has his way – unless, of course, “Ukraine.”)

Consumer confidence was reported Friday at the lowest level in more than ten years – consumers are worried about inflation – and may reduce their buying of non-essential items/services.

So what is the Fed going to do?

They are still buying Billions worth of bonds and mortgages every week, and, despite all the talk, they still have interest rates nailed to the floor. The growth in the Fed’s balance sheet since March 2020 is highly correlated with rising stock indices – if they wind down QE and reverse to QT (as they have indicated they will do), will stocks tumble?

I recently suggested that the Democrats, sensing disaster in the mid-terms, may push the Fed to kill inflation, even if it means throwing the stock market under the bus. (Many voters don’t own stocks directly.)

Some analysts are forecasting that the Fed may be tightening into a recession, creating a stagflationary environment, and tightening monetary policy won’t diminish inflation caused by supply chain issues.

And then the Russia/Ukraine wild card problem suddenly got a lot worse

Late Friday morning, the “news” was that the White House expects the Russians to invade Ukraine next week and advised Americans in Ukraine to leave immediately. The US Dollar, Gold and crude oil soared, bonds bounced while stocks and other risk assets fell.

When gold and the US Dollar are rallying simultaneously, it is usually a sign that capital is seeking safety.

The Euro/Yen spread came in as Europe is at risk of Russia (in more ways than one), and the Yen is a go-to haven.

The Russian Ruble fell on the news.

WTI crude oil jumped >$4 on the “invasion” story, with front-month March nearly touching $95. Backwardation steepened with March 2023 at >$14 discount to Mar 2022.

Before the Russian news hit, Treasury bonds were making new lows for the week (10-year yields hit a high of 2.06%). Bonds caught a “haven” and short-covering bid on the news.

My short term trading

I started this week with no position and stayed flat until Thursday. I was waiting for an opportunity to short the stock market, and it was rising Tuesday and Wednesday. The CPI report scheduled for early Thursday was another reason to wait.

One of my favourite topping patterns is an “M” pattern where the right shoulder is lower than the left. The bounce from the January lows ran into resistance at the Fibro 0.618 level.

The Thursday CPI report was stronger than expected – interest rates lurched higher and kept rising throughout the day. Stock indices, currencies, gold and crude initially fell on the CPI report but then bounced back – until St. Louis Federal Reserve President Bullard opined that the Fed should “immediately” become aggressively hawkish.

I bought the Canadian Dollar as it rallied back from its CPI-induced dip. The stock market was rallying, crude oil was rallying, and the Euro was rallying – all good news for the CAD, and if it broke above the recent highs ~79 cents, it might soar.

The CAD got to 7910 and then reversed along with other markets on the Bullard comments. When I saw the “across the board” reaction to the Bullard news, I covered my long CAD position immediately at a breakeven.

After covering the CAD, I realized I had a great setup to short the S+P. It had bounced back to last week’s highs on Tuesday, dropped from around those highs on the CPI report, jumped back to the “Bullard” highs and started to fall from there. (Falling away from a lower high.) I got short and watched the market fall ~70 points into the overnight lows.

I covered my short S+P for a gain of ~30 points early Friday morning as the market rallied back ahead of the day session opening. I reinstated the position a couple of hours later when there was no follow-through to the opening range rally. The market then began to break down through technical levels and then plunged on the Russia/Ukraine news. With the market closing near the lows of the month, I decided to stay short into the weekend.

I bought T-Notes during the Thursday overnight session, thinking they were extraordinarily oversold and could bounce, considering the weakness in the stock market. The dramatic rise in short-term interest rates added to my view that the Fed could be tightening into an economic slowdown – yet another reason to buy bonds. My setup was buying the Notes after they bounced from a higher low, but I was stopped for a slight loss very early Friday morning – and missed the “Ukraine” bond rally on Friday.

My P+L on closed-out trades this week was essentially flat; I had unrealized gains on my short S+P of ~0.80%.

On my radar

I’ve thought that the American equity markets may have made a long-term top at the beginning of this year. They’ve had an incredible run from the 2009 lows, with a spectacular run since the 2020 lows, but it may be time for a significant correction – something more than 10 to 15%.

Thoughts on trading

Regular readers know that I believe it is essential to keep the time frame of your analysis in sync with the time frame of your trading/investing. I think this is especially important in terms of risk management – for instance, don’t buy something for a short term flip and then decide to keep it as a long term “hold” because it’s gone against you and you “know” it will be a winner if you “give it a little more time.”

I will sometimes “mix” my time frames to find good entry points. For instance, even though most of the trades I write about are short-term, I definitely have longer-term market opinions. For the past several months, I’ve thought that the multi-year rally in stocks was getting long in the tooth. (Essentially, I thought market psychology had got to the point where too many people thought it was easy to make money buying stocks.)

I have a “bias” that the long-term trend in stocks may have topped out (and I should look for opportunities to make money shorting stocks). Still, I know that “having a bias” is not a timing tool, so I will analyze short-term price action to find setups where I can get short – in sync with my longer-term view of market direction. (I only trade futures and options, so by “stocks,” I mean stock index futures.)

Technical traders would likely describe this technique as “trading in line with the trend.” Depending on their preferences, if a market is in a long-term uptrend and experiences a short-term correction, they might “buy the dip” or buy a breakout to new highs. Either way, they use short-term technical signals to buy a rising market.

Quotes from the notebook

“People have an amazing ability to arrive at a solution before truly understanding the problem.” Chris Blundell P.Eng. 2022

My Comment: Chris is a long-time friend, well-read and well-travelled, who has had great success as an entrepreneur in the Canadian oil patch. He used this quote in a recent email to me. His comment is painfully accurate, and wouldn’t the world be a better place if people put a lot of effort and compassion into understanding a problem before offering their solutions?

“You can always (always) find some indicator, somewhere, that will suggest something is a bubble. If you couldn’t, a legion of bloggers running lucrative doomsday-themed websites would instead be serving gimlets to bankers for tips, rather than lampooning them for click money.” Walt, The Real Heisenberg

My Comment: I’ve been a subscriber to the Heisenberg Report for a few years. It’s well-written, biting, and insightful, and I love black humour!

“The lust for yield has overwhelmed prudence.” Bob Hoye, 2017

My Comment: Bob has been a good friend for 40 years. He is a very well-informed market historian and, as you can see, very quotable! A few years ago, I introduced Bob at a conference as a man who knew a lot about the Dutch Tulip Bubble Mania because he had been there while it happened.

The Barney report

Barney and I were home alone for a couple of days this week when my wife went to Vancouver. He was reasonably patient with me in my office, and I rewarded him (tired him out) with long off-leash walks. He is now five months old and just north of 40 pounds.

A Request

If you like reading the Trading Desk Notes, please forward a copy or a link to a friend. Also, I genuinely welcome your comments, and please let me know if you would like to see something new in the TD Notes.

Victor Adair retired from the Canadian brokerage business in 2020 after 44 years and is no longer licensed to provide investment advice. Nothing on this website is investment advice for anyone about anything.

Schachter’s Eye on Energy for February 16

Each week Josef Schachter gives you his insights into global events, price forecasts and the fundamentals of the energy sector. Josef offers a twice monthly Black Gold newsletter covering the general energy market and 30 energy, energy service and pipeline & infrastructure companies with regular updates. We also hold quarterly webinars and provide Action BUY and SELL Alerts for paid subscribers. Learn more.

EIA Weekly Oil Data: Overall, the EIA data of Wednesday February 16th was moderately bearish for energy prices as US Commercial Crude Stocks rose 1.1 Mb versus the forecast of a decline of 900Kb. The main reason for this difference is that Net Imports rose 230Kb or by 1.6Mb on the week. Motor Gasoline Inventories fell 1.3Mb while Distillate Fuel Oil Inventories fell 1.6Mb. Refinery Utilization fell 2.9 points to 85.3% from 88.2% a week ago and this slower refinery activity lowered inventories of products. US Crude Production remained steady at 11.6Mb.

Total Demand rose 860Kb/d to 22.74Mb/d as Other Oils demand rose by 1.019Mb to 5.80Mb. Motor Gasoline demand fell 556Kb/d to 8.57Mb/d. Jet Fuel Consumption rose 102 Kb/d to 1.51Mb/d. Cushing Crude Inventories fell 1.9Mb to 25.8Mb.

EIA Weekly Natural Gas Data: Weekly withdrawals are rising as the cold weeks of winter are here. Last week’s data showed a withdrawal of 222 Bcf, lowering storage to 2.101 Tcf. The biggest US draws were in the South Central (74 Bcf), the Midwest (64 Bcf) and the East (56 Bcf). While a large draw again, it is by no means one for the record books. The largest US draw occurred in early January 2018 at 359 Bcf and the largest draw last year occurred in mid-February with a draw of 338 Bcf. We have now had four weeks of winter draws over 200 Bcf.

The five-year average for last week was a withdrawal of 177 Bcf and in 2021 was 171 Bcf due to mild weather. Storage is now 9.3% below the five-year average of 2.316 Tcf. Today NYMEX is US$4.52/mcf due to an expected colder spell in the coming days. AECO is trading at $3.59/mcf due to the milder weather in western Canada. February (being the key winter month for natural gas demand), is still likely to see price moves to the upside on very cold days. After winter is over natural gas prices typically retreat and if the general stock market decline unfolds as we expect, a great buying window should develop at much lower levels for natural gas stocks in Q3/22.

OPEC January Monthly: On February 10th OPEC released their February 2022 Monthly Forecast Report (January data). As repeated in the past few months they have not added the 400Kb/d, their stated monthly production increase. In January only 64Kb/d was added. Production rose to 27.981Mb/d but remains below the 29.368Mb/d produced in December 2019 before the pandemic hit. So they still have nearly 1.4Mb/d to bring on just to get back to pre-pandemic levels. Moral suasion by the US, China and India does not seem to be influencing OPEC’s production decisions. OPEC may be watching events in Europe and may be standing by to add more production if energy export sanctions are implemented against Russia upon any invasion of Ukraine. Saudi Arabia and the UAE alone could add 2.5Mb/d if they wanted to.

The biggest increase came from Nigeria at 81Kb/d, followed by Saudi Arabia at 54Kb/d and then by UAE at 44Kb/d. Surprisingly Kuwait only added 27Kb/d to 2.58Mb/d, even though they could have added 130Kb/d more just to get back to 2019 pre-pandemic levels of 2.71Mb/d. Sanctioned Iran saw production rise by 21Kb/d to 2.503Mb/d. Venezuela saw a decline of 51K b/d as they could not get sufficient diluent this month from Iran, China or Russia. OPEC sees 2022 consumption at 100.8Mb/d, up 4.15Mb/d from the 96.63Mb/d consumed in 2021.

Baker Hughes Rig Data: The data for the week ending February 11th showed the US rig count rose by a significant 22 rigs (up three rigs the prior week) to 635 rigs last week. Of the total rigs working last week, 516 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 60% from 397 rigs working a year ago. The US oil rig count is up 69% from 306 rigs last year at this time. The natural gas rig count is up a more modest 31% from last year’s 90 rigs, now at 118 rigs. Texas had the largest increase in rigs with 13 added last week and the total rising to 300 rigs. The Permian (Texas and New Mexico) added seven rigs taking the total rigs working in this lucrative basin to 301 rigs.

Canada had an increase of one rig (up one rig last week as well) to 219 rigs. Canadian activity is up 24% from 176 rigs last year. There was one more oil rig working last week and the count is now 137 oil rigs working, up from 101 last year. There are 82 rigs working on natural gas projects now, up from 75 rigs working last year. Staffing of rigs in Canada is becoming a problematic issue and adding significant more rigs in the near term is unlikely. While day rates are rising, so are costs and margin improvements so far are not what one should expect as the industry activity picks up.

The overall increase in rig activity from a year ago in both the US and Canada should translate into rising liquids and natural gas volumes over the coming months. The data from many companies’ plans for 2022 support this rising production profile expectation. We expect to see US crude oil production reaching 12.0Mb/d in the coming months. Companies are taking advantage of attractive drilling and completion costs and want to lock up experienced rigs, frack units and their crews as staffing issues are difficult for the sector. We expect US production to reach 12.5Mb/d before the end of this year.

Conclusion:

Bearish pressure on crude prices:

1. The Omicron pandemic is far from over but is losing its impact on individuals’ reticence to move about. Usage of energy as mandates are loosened and vaccination rates have risen is increasing especially for Jet Fuel. Covid-19 deaths are rising for the unvaccinated. Deaths in the US have reached 922K (up 16K over the last week) and worldwide has reached 5.83M.

2. The window for Russia to invade Ukraine is closing. If they want to move in they need to do so in the next two-three weeks or they will miss the window. Heading into mid-March the ground of attack will have thawed out and an invasion becomes unlikely. The window for exercises ends on February 20th so around this date is the window for any military action. Some NATO sources now see Russia having 180K troops in position to invade and that Kiev could be a key target.

A few days ago Russia acknowledged that it was willing to go the diplomatic route. Was this part of the poker game or a sign of good faith? They say that they have removed some troops from the front lines, however NATO does not see sufficient evidence of this but rather sees more troops being added across the invasion routes. Is this a removal of troops needing maintenance on their equipment and maybe some R&R, before being brought back to the front lines? Russia has staging areas deeper in Russia and Belarus as well as forward bases close to Ukraine’s border. In the meantime Russian hackers have increased their cyberwarfare attacks in Ukraine. Ukraine’s military (command and control) services and two large banks were targeted in recent days.

3. The Iran nuclear negotiations are working towards sealing a deal and having sanctions removed so that they can sell their oil around the world. Negotiations appear to be making a breakthrough with a timeline of the end of February. President Biden may be giving away more to Iran in order to have sanctioned Iranian oil available if Russia invades Ukraine. If Iran receives sanction relief it could increase production by over 1.5Mb/d almost immediately. Iran also has over 200Mb in storage around the world near its buyers, so those volumes could be added to supplies quite quickly.

Bullish pressure on crude prices:

1. Russia provides over 26% of western Europe’s crude oil needs and around 41% of its natural gas needs. Any sanctions on these sales would not be easily met by other producers. This effectively is a two-edged sword. The US is sending over more cargoes of LNG and has asked Qatar to do the same. While the Nord Stream 1 pipeline is operational with gas flowing into Germany, the second pipeline is part of the potential sanction regime by President Biden. Germany may accede to this but has not done so publicly as they desperately need the natural gas. Current levels of imports into EU countries may stay at current levels but increases (especially of Nord Stream 2) will not be permitted.

2. Russia has threatened increased cyber attacks against Ukraine and NATO countries (including the US) if President Biden escalates pressure on Russia upon any invasion activity. Cyberwarfare against Ukraine’s infrastructure and military control systems has already started. The US and many other countries have ordered their citizens to leave the country and have closed their embassies in the capital Kiev moving some personnel to Lviv in western Ukraine near the Polish border.

CONCLUSION:

The concern about an imminent invasion of all of Ukraine continues to spike crude oil prices higher. WTI rose to over US$96/b this week. WTI today is at US$94.82/b. If Russia just moves on eastern Ukraine then crude could spike to nearly US$120/b. If Russia plans on taking over all of Ukraine and places its military on the borders of Poland, the Baltic countries and Romania, facing off against NATO forces, then crude oil prices could spike even higher. We do not see Russia planning to go that far. It may want to gather the Russian speaking people in eastern Ukraine into its orbit and have a land corridor to Crimea, but anything more would invite insurgency warfare in western Ukraine.

If there is no invasion in the next short while and no sanctions against Russian energy exports occur, then the price of WTI crude should retreat quickly towards US$62-65/b as the war premium is removed and weak economic data around the world hint at recession this year. If sanctions against Iran oil sales are removed by an agreement during March, then crude oil prices would head down quite fast.

Energy Stock Market: The S&P/TSX Energy Index currently trades at 204 (up eight points over the last week) as the war event window closes in.

Our February SER Monthly Report comes out next Friday and covers the latest signs of internal deterioration in the general stock market and increased weakness in key world economies. Significant stock market downside is ahead and investors should be defensively prepared. The MEME stocks have been massacred and a few of the FAANG and related stocks have been severely eroded in value (Meta-FB, Netflix, Roblox, Shopify, Viacom and Zoom are just some of the recent sharp decliners) Remember how you felt in the later stages of bear markets as were seen in 1987, 2000, 2008, and 2020? Prepare yourselves for this impairment risk to your assets. Last week alone we had two down days over 500 points in the Dow Jones Industrials. Much greater daily declines are likely in the weeks ahead.

Our February SER report covers this painful market situation. The Q4/21 and year end results for 2021 are starting to be released for the 30 companies that we cover. In next week’s issue we cover those companies that have reported by the close on Friday February 18th. In the March issues we will cover the rest of the regular reporting run.

Our Q1/22 quarterly SER webinar will be held on Thursday February 24th at 7PM MT. If you want to join/register for this event or access our Interim Report or the upcoming SER Monthly become a subscriber. Go to https://bit.ly/34iKcRt to subscribe.

Please feel free to forward our weekly ‘Eye on Energy’ to friends and colleagues. We always welcome new subscribers to our complimentary energy overview newsletter.