Until recently, momentum behind the effort to turn US crude's bullish range reversal into a clear trend has been relatively reserved. That is until Tuesday when the active futures contract cleared a notable range resistance around $76 and $75.50 and proceeded to overtake the 200-day moving average. A quick appraisal of the bearing and activity level of the broader speculative market leaves little doubt as to what the primary driver for today's breakout was - risk appetite. For context, the benchmark US equity indexes put in for daily advances greater than 2 percent, which subsequently offered a meaningful breakout from congestion and push to monthly highs. The source of this sentiment is debatable. It would be easy to cherry pick economic indicators as the foundation for this rally; but that would be short-sighted and erroneous. In reality, the strength in the capital markets can be attributed to a natural correction following a sharp decline in speculative assets that was magnified by the imminence of a potential financial crisis blossoming out of the European Union. While conditions continue to deteriorate in this region, the threat of a seizure in credit and lending has lost some of its intensity. Therefore, in the absence of an event or news that could capsize stability market-wide, oil and other speculatively-guided assets could continue their advance until risk premium has balanced out.
Another consequence of the recovery in sentiment is the impact it has on the US dollar. The safe haven currency is the primary pricing instrument for oil (and especially the New York based light sweet crude contract); and considering the single currency had rallied steadily for seven consecutive months without a significant correction, a reversal can last for some time and cover significant ground. We can already see the effects the greenback is having on oil prices. Whereas the US-based crude futures contract has rallied to a new high when measured on a dollar-basis, the market is still restrained to a 62.75 / 60.25 range when calculated in euros. Speaking of crude priced in different currencies, Europe's benchmark crude contract - the ICE-based Brent contract - rolled over from the July to August expiration. The difference between the US and European standard has widened to $0.61 in the WTI's favor - the biggest positive skew since April 6th. At the same time, the rebound in the active NYMEX futures contract coupled with a drop in the CBOE crude oil volatility index to its lowest level in over a month (37.7 percent) has helped to ease fear in the form of a greater premium for the contract set for expiration two years down the line. The difference between (contango on) the July 2010 and July 2012 contracts dropped to $7.89.
For fundamental considerations Tuesday, supply and demand have both seen adjustments (though output will likely have little long-term baring on price unless there is a dramatic shift). For supply, the API inventory figures for the week ending June 11th rose for the first time in three weeks by 579,000 barrels. This sets Wednesday's more closely watched Department of Energy readings up for a potential surprise. Bloomberg's consensus forecast is for a million barrel drop to follow up on the previous period's 1.83 million barrel contraction. On the demand side of the scales, the macro data on deck yesterday morning was encouraging. A leading indicators composite index for China unexpectedly reported its biggest jump in 14 months, suggesting momentum behind the world's second largest economy could carry energy demand higher. Yet, it is also important to point out that this was a reading from April. The Empire manufacturing index was similarly encouraging, reporting the 11th consecutive month of growth. Yet, neither of these indicators barely budges the global outlook.
John Kicklighter is strategist with DailyFX.com.
