Beware of market complacency
Asense of calm has descended on the world financial markets, most noticeable stock markets where volatility on the S&P index has dropped to a two-year low. During May 2008 the S&P index reached a high of $1,440 which was followed by a major sell-off in the months that followed.
The VIX (volatility index) is a measure of fear for the unknown.
During periods of market turmoil, the VIX rises reflecting the increased cost of insuring (buying put options) against further losses.
During bullish periods, like the one we have had for several months now, there is less fear and less need for buying insurance.
Looking at recent history, we have often seen that a VIX reading below 20 per cent, currently 16.50 per cent, has been followed by a major sell off shortly after. This complacency is worth keeping in mind as we head towards the second quarter of 2010.
With the economic outlook continuing to brighten, there are only a few clouds on the horizon. The ongoing uncertainty about Greece's sovereign debt problems and the potential risk of it spreading to other countries, risk about a bubble emerging in the Chinese economy and speculation about how the markets will react to the first round of Central Bank tightening when it occurs are the major concerns.
Against this background, the major commodity markets have been trading calmly.
Crude oil has been grinding higher over the past couple of weeks, reaching $83, which ahead of the $85 level has been difficult to breach. Opec decided to stick to their agreed production cuts and expressed satisfaction about current levels.
Short-term momentum can and probably will carry prices higher but that will increase the risk of the market running ahead of itself and a sell off could be the result. The speculative long positions, as measured by number of open futures contracts on Nymex, has once again moved back above 110,000 lots after reaching a low of 42,000 lots during the February sell off. In January, when the winter rally was at its peak, the speculative long position reached a record 135,000 lots, which was subsequently followed by a $15 sell-off in prices.
Technically, a break above the recent high will target $85.60 with a potential extension to $90, which is 50 per cent retracement of the 2008 sell off from $147 to $33. Support can be found at $79 and $77.50.
The price of natural gas continues to fall out of the bed, reaching a five-month low at $4 after having fallen by a third since the peak of the winter. The slower-than-expected draw of inventories this past few weeks has left the surplus 4.7 per cent higher than the five year average.
The market is facing weak fundamentals with increased production due to higher rig count and better efficiency. Companies are finding cheaper ways to produce and new areas to produce in.
Forecast for milder than normal weather in the coming weeks indicates that the US will end the winter with plentiful stocks and the rebuilding of stockpiles will begin from a higher level than normal.
The front month of April natural gas on Nymex is near-term primarily only supported by a much oversold RSI which indicates a bounce is imminent. How quickly that bounce will be met is the big question with major resistance now at $4.60.
Gold has spent the past few weeks consolidating above $1,100, but at the same time, it has failed to make any attempt on the recent highs at $1,145. The speculative long position on Comex has begun to climb again, reaching 21 million ounces with the December 2009 record of 26 million getting closer. We continue to watch the dollar for clues about the next move, and are looking for the above-mentioned range to hold.
- The author is Senior Manager for CFD and Listed products, Saxo Bank. The views expressed are his own
Follow Emirates 24|7 on Google News.