Chinese equity decline driving energy price discovery

July 27, 2015 10:02 AM

It has been a difficult time for commodities across the board, at least from a long perspective. Until recently, it was the shorts in markets that have been struggling as the global crises like China and Greece did more to stop rallies rather than actually produce any real selling.  

However, during the past two weeks we have seen the bears take control of the price discovery across multiple commodity sectors such as energies, agricultures, metals and equity indices. The pressure in the commodities can be mostly attributed to the concern over a weakening China as the overnight session has seen an over 8% dip in Shanghai, the worst single day move in eight years.

This is especially relevant as China has been active through both monetary policy decisions and regulatory decisions in recent weeks aimed at curbing the sell off their previously inflated indices. It is important to note that the selling in Chinese equities is exasperated by the methods that many market participant have been involved in the last several year rally could be equated to the housing bubble here in the United States back in 2008. Many investors are significantly over leveraged using very favorable margining percentages that have put those position in peril as margin calls have forced significant selling, pushing the market farther down than any actual fundamentals would call for. That being said, we could see a significant rubber band effect as those weak longs are filtered out. 

For energies, we are seeing this China effect manifested most significantly in the crude oil market with it trading at four-month lows as the market searches for a bottom. At 47.50, the several year low is within striking distance only 4 dollars lower at 43.50 on a continuous basis. The Iran deal, over supply as U.S. rigs come back online and demand issues due to China and Greece are all bearish pressures that could force the issue and test new lows. None of those fundamentals are strong enough to produce those results alone but they just may be together in this sort of perfect storm scenario. 

However, we continue to look for buy areas in the belief that the price discovery is already over done thus making the bounce higher more likely and possibly very substantial. It is interesting to note that the spread between Brent crude and WTI has roughly maintained that approximate 6 dollar differential Brent over WTI. That would seem to indicate that the pressure is less specific to the actual commodity and more about a general commodity malaise. 

Natural gas did see some selling at the end of last week on the heals of bullish inventory data.  It seems that the aforementioned commodity short squeeze was more than the delicate rally could bear.  Nonetheless, the decline was the least significant in natural gas versus almost all other fading commodities. That alone is, if not bullish, at least not bearish either. We continue to wait for the $3 handle again with the price discovery stuck in about a 20 cent range during the past six weeks. 

About the Author

Tory Enerson is a senior market strategist with the Zaner Group in Chicago, an Independent Introducing Broker. He has been in the futures industry for over 20 years. Beginning his career at the CBOT in 1990, Enerson worked his way up through the industry when he became a member of the CBOT in 1998 and traded for over a decade before beginning to work with clients as a market strategist.