May 18, 2017 - 5:25 AM EDT
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Crude Oil and Market Psychology

Markets are brimming with enthusiasm these days as analysts search for that “golden-thread” that runs through all market scenarios and brings the price of crude oil back above $60, maybe even $100 per barrel. Stories like “OPEC Overshoots It’s Target” or “Saudis and Russians Agree to Export Reduction”, and stories that foretell a geopolitical calamity that shuts down the world’s east-to-west trading routs are bubbling up everywhere in an effort to gain traction in a very uncertain world.

At first glance, you must be saying to yourself, there is nothing that ties these scenarios together. I thought the same thing, and then I remembered the power of suggestion and value of market psychology. Today, we will tackle the “golden thread” that ties these scenarios together: Market Psychology.

As an economist, I ask myself, why do traders and analysts need a golden thread. The answer is quite simple; we all want and need to be right. However, as a coin has two sides, so does a market. Producers often have different opinions on where prices are or where they will go than do traders or analysts because they only gather profits from one side of the market. Traders and analysts, on the other hand, can make profits on either side but must have a sustained rally or a bust to gather their profits. The bottom line here is everybody wants to be right and be able to say, “I predicted this market change”. The problem is markets tend to follow their own path—kind of like that old cow trail on my ranch, and they both meander!

How Market Psychology Impacts Oil Volatility

Market psychology, as it relates to the crude oil complex of markets, is defined as the sentiment held by traders in a particular market. Market psychology tells us, if the psychology is positive and wants prices to rise, they will rise; even if market fundamentals—also known as bits of information that move a market—contradict this action. The opposite is true as well. The interesting dynamic here is that as market fundamentals fade into hopes for higher prices, market psychology usually becomes more pronounced. Once market fundamentals strengthen, market fundamentals tend to overshadow market psychology and take the market in another direction. The contrast here is the strength of the fundamental relative to the strength of the market psychology.

Right now, in the US-based West Texas Intermediate (WTI) crude oil, it seems to be stuck in a comfortable range. Traders and producers are trading right at the breakeven point for most US crude production and markets are getting tired of the status quo! Look at the chart from June 2014 to February 2016. The market fundamentals were such that the price for WTI dropped with world oversupply, completely killing market psychology.

The chart shows the influence of the fundamentals that cast a persistent shadow over the price of crude oil for 21 months. Once we hit a psychological low near $25 per barrel, for no other reason than for the psychology of the traders, prices rose again. Now for the last eight months, traders and analysts are trying to talk the psychology of the market back up and beat back the fundamental drivers in this market.

Periods of more profound market psychology are easy to spot, just look at a chart and when prices are trading in a tightly bound range, that’s where you’ll begin to see greater influence from market psychology over time.You’ll read stories about “Markets bounced off a psychological low of $45 today” or “Markets didn’t break through the psychological high of $55 today”. This scenario is exactly where we are trading right now. Traders are tired of the same stagnate trading range and desperately need a change, so over time, the stories begin to emerge to push prices higher in anticipation of a change. The chart below depicts a period of time when there is not a strong enough market psychology to push prices one way or the other, or fundamentals.

The Market’s Current Psychological State?

Over the weekend, we bounced off the $45 psychological low in WTI and are heading toward the range-bound, psychological high of $50 per barrel. The fundamentals or news that moved the market was the Saudi and the Russians agreement to freeze exports, to help keep more crude oil out of floating world storage and help boost prices. The story helped, but wasn’t strong enough yet to push through the $50 price for WTI, yet.

Have you heard the old expression, “Throw enough stuff against the wall and see what sticks”? Well today, analysts are doing just that. Let me paint a clear picture here. The markets have been trading in a range of between $45 and $53 per barrel; so we’ve satisfied the requirement to become “psychology sensitive”. Traders and producers alike need prices to rise during the peak demand portion of this year; that’s the early summer. The current market fundamental, supply, is improving, but is it enough to offset the growing US production or, for that matter, slowing demand within the US and around the world? This is the perfect set-up for a psychological push through the top of the range we have been trading for these many months. It’s time for the crazy stories to come out and try and influence the markets.

A Market of “What Ifs”

On Monday of this week, I read all of these stories. OPEC was not meeting production cut goals. I read that OPEC will meet their goals and over-shoot them, causing massive shortages in the market. I read a story projecting $100 WTI again with its premise being a supply glut will completely disappear by the end of the summer and needed oversupply cushion will then be gone. Then I read where the lack of hurricanes over the last 10 years will catch-up with us this year, and the lack of attention we are now giving to the tropics will be our undoing. Lastly, I read a story foretelling of an impending North Korean nuclear attack on Anderson Air Force Base, where we house various medium- and long-range bombers. While all of these could happen and explode prices, we better be satisfied with the current fundamental drivers in our markets.

All of these stories except one were designed to change the market psychology in the WTI market and begin a psychological rise in prices before the actual market fundamental hits the tape and prices actually rise. This is the influence psychology in the market place and will be driving prices, until none of it happens and the price of WTI falls back below the bottom of the channel, like it did at the beginning of 2016!By Tim Snyder

Read More from Crudefunders

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Source: News (May 18, 2017 - 5:25 AM EDT)

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