While Deutsche Bank (who made the June call to go short) isn't exactly saying that the downward slide will end soon but they are saying the risk/reward isn't worth it to be short anymore. That at least means this might end soon. From my view, there's a new problem now and that's keeping some major economies from collapsing. #1 is Russia.
Oil bears have had a lot to be joyous about since midyear but it might just be the season to start booking profits on those short bets, Deutsche Bank’s top asset allocation strategist said Monday.
In a note, Deutsche Bank’s chief strategist Binky Chadha identified three factors that had led Deutsche to recommend short positions back in June. Those three factors that earlier supported making betting that crude oil prices are on the decline now argue for short covering, he said.
Here they are:
The overvaluation gap has closed: In June, oil prices were 45% above fair value. Now, even though fair value for New York Mercantile -traded, WTI crude oil has dropped from around $80 to $58 thanks to a sharp rise in the dollar, the large fall in oil futures CLF5, -3.76% have closed the overvaluation gap (see chart at top of page), Chadha noted. Nymex WTI futures closed Monday at a five-year low of $55.91, down more than 48% from its June high near $107 a barrel.
Skew has normalized: A measure of volatility, the oil “put skew” by June had fallen well below its range over the previous five years, a contrarian signal that the market saw oil prices as unlikely to fall. The so-called skew is now back within its previous range, though it has been volatile as the market moves between pricing in a bottom and further declines, Chadha wrote.
Weak longs thinned out: Net speculative long positions in oil futures stood at record levels in June. While still historically high, net speculative longs had fallen to a 1.5 year low by early October and have remained there, Chadha noted. He acknowledges that still large net speculative long positions are the biggest risk to taking off short positions too early, but he suspects many of the remaining gross long positions are tied to longer-term asset allocation positions in oil and commodities “that are likely to be sticky.”
Chadha says the risk-reward picture now argues for closing short positions in oil. Any further fall in oil futures, particularly if the dollar trades flat, would represent “overshooting, which we would prefer not to chase,” he said.
Also, while traders were pricing in “too much” geopolitical risk to oil supply in June, the market “is now pricing almost none,” Chadha wrote.
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