Contango

Following our discussion of perhaps the most successful (and/or most risky) trades of the last decade - that of shorting the front-month VIX - we were less than surprised that VXX -the VIX ETF has collapsed to new record-lows this morning. A snap higher in VIX has been met by an avalanche of vol selling and, as we discuss below, the accelerating contango as expirations loom has encouraged yet more to take on unlimited risk positions to pick up pennies in front of the steamroller. All the time "The Fed has your back," it appears traders believe the steamroller driver has his foot on the brake... As if on cue - VIX has spiked and VXX surged.

If the longs use VIX products as hedging instruments, then why would anyone take the other side? Because, being short volatility can be very profitable, according to Goldman. Year-to-date this short vol index is up 56%, and selling the front-month VIX has earned a massive 114 vol points... The introduction of weekly VIX futures (and the exponential decay implied by these volatility-inducing instruments) offers, according to Goldman Sachs, even more opportunity for active risk takers to sell vol, scrape premium, and face unlimited downside risk... playing the contango collapse game until there are no more musical chairs left.

In a January 2013 report “Report of the Working Group to Study the Issues Related to Gold Imports and Gold Loans by NBFCs”, the Reserve Bank of India estimated that the ratio of paper gold trading to physical gold trading is 92:1. That is a lot of unbacked paper gold instruments. This has almost entirely separated the “gold price”, such as it is (the clearing price for vast volumes of paper gold “representations” with a fractional backing) from the fundamental supply and demand dynamics for actual physical gold bullion.

As Mr L. famously quipped. "Ever get the feeling you’ve been cheated?"

"The oil rebound has run out of gas and now you are seeing nervous investors with itchy trigger fingers bailing out of USO," notes Bloomberg, as the biggest US ETF that tracks oil is heading for the largest two-month outflow in six years, raising concern that crude’s 30% rally may stall. As BNP points out, "we do not think that the bulls have enough supporting fundamental factors to make a case for a higher oil price," and judging by the mass exodus from USO, as Bloomberg concludes, knife-catching 'investors' "don’t want to get burned by another drop in oil."

As with everything in life, there are winners and losers, and the recent rout in the oil market is no different. The four flip sides below should be closely monitored in the coming months, for the oil market will be impacted by these factors – regardless of if they change their tune, or become a broken record.

A constant stream of hyprocrisy from Fed officials (will print moar money if stuff happens), The EIA (storage is getting fuller and fuller, but production will be lower than expected), and Saudi Oil Minister Naimi's idiocy (increased production, demanding non-OPEC cooperation, but optimistic on prices recovering in the short-term) has sent crude asymmetrically rocketing higher... which is now apparently a good thing for US equities.

Even before the disappointing US jobs data, we anticipated a downside correction in the dollar after a sharp advance in Q1.   

As the market ponders how quickly an Iran nuclear deal and subsequent lifting of sanctions will affect crude prices, record production in Iraq leaves 5% of the world's tanker fleet parked in the Persian Gulf.

Fifth ramp in 5 days takes WTI crude back above $49 for the first time in 2 weeks... on the heels of record production, record streak of inventory builds, and record inventory at Cushing. The 1Y spread has compressed to 2-month lows...

U.S. oil producers are issuing new shares of stock at the fastest pace in more than a decade, looking to investors for a cash lifeline to pay down debt and keep drilling as crude prices continue to sink, Bloomberg notes, a move which paradoxically will only serve to depress prices further. 

"The debt borne by the oil and gas sector has increased two and a half times over, from roughly $1 trillion in 2006 to around $2.5 trillion in 2014. As the price of oil is a proxy for the value of the underlying assets that underpin that debt, its recent decline may have caused significant financial strains and induced retrenchment by the sector as a whole. If the adjustment takes the form of increased current or future sales of oil, it may amplify the fall in the oil price.

10 days we warned "the sharp slide in crude prices may be leading the proverbial sheep to slaughter," as we noted ther surge in Oil ETF USO's shares outstanding and the spike in Oil price contango - a potentially ugly combination for an ETF ahead of the roll. Since then, USO has indeed tumbled over 14%. However, it;s not over yet - in the last 3 days alone, the USO share count has soared 10% (the fastest pace in 2 months) almost at its Feb 2009 record highs as investors "know" the bottom is in now and continue to catch the gapping-lower-every-day, massively contango'd, ETF knife...

Just a few short days ago we were the first to bring attention to the potential of an Iran nuclear deal being a catalyst for the next big leg lower in the energy complex and sure enough, not only is the market startuing to leg lower in a hurry as the deadline looms, but the mainstream media is catching on too. WTI hit fresh cycle lows this morning at $42.63 with the contango continuing to surge.