Exclusive Gasoline Analysis: The Running of the Bulls

The rush away from the petroleum market

Published in CSP Daily News

By  Walter Zimmermann, United ICAP

NEW YORK -- In my October article, I noted that from 2010, gasoline prices had in a shrinking trading range just below the all-time highs. Coming into 2013, gasoline production had been pushing record high levels, gasoline supplies have been mounting toward record highs, and gasoline demand has been in decline for many years now.

Despite all these bearish developments, we noted that gasoline sentiment had remained stubbornly bullish. The persistently bullish outlook for higher gasoline prices did not match the shrinking gasoline trading range … or the falling gasoline demand, or the rising gasoline production, or the rising gasoline inventories.

As the persistently bullish outlook for gasoline had absolutely nothing to do with gasoline fundamentals, we concluded that near unanimous expectation for higher gasoline prices was strictly a function of bullish economic expectations. And this brings to light a truly remarkable situation: These days people are bullish on the economy because the economic recovery is so feeble that they expect continuing Federal Reserve stimulus. In effect, the outlook for the economy is so bullish because the economy is so weak. How is that for logic!

This is the dynamic behind the current stock-market bubble. The equities bubble continues to inflate to new all-time highs because the economy is so weak. Now it is one thing to bid up the stock market on the basis of Fed stimulus. It is quite another thing to be long gasoline on that basis. The conclusion of my October report was that gasoline bulls were “headed for a big disappointment.”

Spot gasoline futures prices just broke down to new multi-year lows. And as a result of this long awaited break down, for the first time since June 2012, gasoline sentiment is net bearish (See chart below). The big question is whether this flushing out of speculative length represents a buying opportunity.

Gasoline price trends are extremely seasonal. Averaging out the last 30 years of spot gasoline futures (from leaded, to unleaded, to MTBE, to RBOB), one finds that the average winter-to-spring price move has been a 57% increase in spot contract value. By Q4, everyone is typically bearish on gasoline because prices have been under downward pressure since Q2.

Over the years we have observed that the more severely gasoline prices are pushed lower into Q4, the more vibrant the rally into Q2. So in the bullish case, the most recent dump lower in gasoline prices is an entirely seasonal event that suggests there are likely to be buying opportunities out in the Q2 2014 contract months.

However (yes, there is a however here) commodity prices have been deflating since the commodity bubble burst back on July 7, 2008. Commodity prices, gasoline included, fell sharply from 2008 into 2009. Then there was a recovery into an April 2011 high. However from those early 2009 lows, gasoline prices rallied much more sharply than the broad-based commodity market.

And since the April 2011 highs, gasoline prices have held up much better than the commodity markets at large. The contrast is striking (See chart above). And this raises another possible explanation of the recent exodus of bulls from out of the gasoline market.

Could it be that the deflation that has been pummeling the commodity sector is just now catching up with gasoline prices? Should this be the case, even if gasoline has a preseason rally from Q4 of 2013 to Q2 of 2014, it is likely to be a sub-par rally. We should not be completely surprised if gasoline’s attempt to stage a preseason rally yields in an advance that, compared to previous years, is abbreviated in both duration and extent.

Of course this continuing deflation in the commodity markets raises serious questions about the durability of the stock-market advance. If the economic recovery were for real, if the stock-market advance were not merely the next speculative bubble, then surely commodity prices would be inflating, not deflating. But that is a subject for another time.

Keywords: 
fuel prices, petroleum