Oil Is VIX'S New Best Friend
IG | Feb 03, 2016 05:03AM ET
Oil is the VIX’s best friend
The two areas affecting the markets over the past five to six weeks all came to a head in one US-European session as the relationship between oil and volatility drove everything lower.
Oil - Jawboning 2.0
"We are open to further cooperation if there is a desire from everyone to really hold this meeting spoken about"
- Russian Foreign Minister Sergei Lavrov.
This is jawboning 2.0 and it’s exactly why we suspect ‘no cuts’ will occur to the supply side. ‘From everyone’ will never happen - we have seen over the past 24 months that OPEC cannot agree on anything, let alone offering the chance for Russia to now enter the talks to cut supply and for the bloc to work as a unit.
We reiterate base case thinking that the supply side will continue to cause price spikes on ‘possible coordination’ rather than actual action. Remember – talk is cheap.
Venezuela, Algeria, Nigeria and Iraq are all welcoming cuts – all have made comments to that effect in the past five days and all have a vested interest in doing so. Particularly Venezuela and Nigeria due to the following reasons:
o The Venezuelan oil price hit US$26 a barrel yesterday. It has US$10 billion of repayments due in 2016; estimates put the revenue Venezuela will generate from its oil out at US$20 billion in 2016 on current metrics. Default is almost inevitable if the price does not move higher
o Nigeria asked for US$3.5 billion in emergency loans on Monday to plug a US$15 billion deficit left by the collapse of the oil price.
Tehran, however, has rejected these calls and is unwilling to entertain the idea of cuts in any shape or form.
The other issue with OPEC and non-OPEC nations like Russia is stockpiling and supply-side numbers are opaque. This means the only weekly/monthly metric to watch is EIA and referring that to world supply.
EIA numbers over the past three months show record stockpiling, the highest level of short interest in WTI and, despite a decline in drill rig counts, data is not showing a substantial decline in US supply side.
The BP (L:BP) results in London overnight is, in my view, the beginning of a bottom-up pain that will be felt for at least the next six months by majors, minors and everyone in between. It’s likely to get worse before it gets better.
WTI fell back below US$30 a barrel to US$29.90. Brent fell to US$32.69 a barrel.
Oil trades
The interesting trading pattern here is that any news (positive or negative) at the back end of last week was used as a buying opportunity.
In the main, the trade activity last week appears to be short covering. The fact oil has had its worst two-day trading period since mid-2010 to start the week suggests the bears are back in full control and reinstating positions put in place in December and early January. We are following the trend.
Get The News You Want
The relationship between oil and the VIX remains strong and, in my opinion, the VIX bull case is leading.
VIX bull scenarios for 2016
US markets re-base: hyper-inflation from the seven-year bull market brought on by the Fed’s QE programs filters out, leading to a sharp equity selloff. Fed speak this week has been disjointed and inconsistent. Growing market theory of a ‘one done, all done’ scenario.
Manufacturing and industrial productions prints remain in contraction or at decade lows. ISM numbers this week were poor and back at 2009 levels.
CNY ‘surprises’ the markets with a sharp devaluation. Chinese stimulus programs have ramped up in the past week. Last night’s policy changes to lending rules are also designed to improve credit accessibility.
Employment starts to feel the squeeze and slows.
Reiterating the base-case scenario: VIX will average above the yearly average of 17.3 (past 25 years) in 2016.
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