Crude: Smell the fear

August 11, 2017 08:25 AM

Crude oil prices are selling off in fear! Fear that a falling stock market may slow demand and fear that a prediction by the International Energy Agency (IEA) that oil demand might be lower, might be right this time. Yet, the biggest fear that is rattling at least one major commodity brokerage firm is the exposure to the short volatility trade.

The VIX trade has confounded many investors as the lack of fear in that index seems to be out of whack with reality. One could argue that the index might be broken because it only focuses on short term volatility and therefore is not a valid index for fear or risk. Yet, with tensions rising in North Korea and other Geo-political hotspots the big bets on complacency may actually start to blow up. Many Hedge funds and algorithm high-speed traders have sold volatility short to make up for losses on other trades. Shorting volatility was like printing money yet now the risk is rising at a potential massive unwind.

This risk has caused a major commodity and stock firm, that clears many types of these traders, to warn that they are acting by raising their margin requirements on all volatility positions considering what could bea a major move. A major move that could blow up many funds and traders.

They say that the VIX has established new all-time lows over the course of the past month. The price dynamics of that product are such that it can have a very large relative price increases during a short period based on news and other factors. In recognition of the special risk of sudden large increases in market volatility, that is inherent in volatility. Products like VIX will cause this brokerage firm to put into place greater margin requirements for volatility products starting on Saturday. They will base the margin on market outcome scenarios for a rise to 18, that, of course, will be subject to change. 

With many VIX options expiring, and the short VIX traders being hit with postilions and margins, the firm is basically warning that they better have more funds or risk being taken out; regardless of the position. Firms must do this at times to offset risk but the action is raising concerns about what may happen if North Korea goes ballistic over the weekend. Perhaps we will see some short VIX traders and algo traders that want to be the fastest, but maybe not fast enough to not get blown out if things blow up.

Oil prices were soaring on Geopolitical risk and strong demand but the tumbling stock market caused a resale. Oil rallied after a report from OPEC that saw OPEC production rise because OPEC raised its demand forecast. Yet, a report that Russia was restarting oil fields and planning to raise production after the current OPEC-Nonlooped accord ends shook the longs. Then the stock market sells off and the rest of the day was a downer. Today the International Energy Agency is lowering its forecast for demand and that is adding to a bearish oil mood but the IEA has not got demand right in some time!! Recent demand figures from the United States and Asia would suggest that the IEA is going to be wrong on demand once again. 

I put out a special gold report a month or so ago on all the reasons to be long gold. One billionaire apparently agrees. Bridgewater Associates Founder Ray Dalio said to buy gold as he said that "Prospective risks are now rising and do not appear appropriately priced in," Dalio wrote in a LinkedIn blog post. "The emerging risks appear more political than economic, which makes them especially challenging to price in."

So, you should allocate 5% to 10% of their portfolios to gold. But not bitcoin!  Read my gold outlook in my Special Gold report (call me at 888-264-5665 or e-mail me at to get it) that agrees and gives more reasons why gold is an important buy. Natural gas has turned the corner. Hurricanes and heat and an injection report that showed the cushion over the five year average of supply fell to a meager 2%. Not very comforting as U.S. demand and exports are rising!

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.