Technical Analysis
Chart Reading: Chinese Stock Market Breaks Down from Bearish Flag
Chinese leading Shanghai Stock Index (SSEC) broke out to the downside today, confirming the bearish flag formation that has been running from mid-August. SSEC falls over 6% or 192 points in one day (8/31) to 2667, starting a new leg of selling. The target of this round of selling would be 2300.
Below is the chart showing SSEC index as of Friday, 8/28
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Chart Reading: Shanghai A Share Index and Morgan Stanley China A Share Fund (CAF)
Since last November, China Shanghai A Share Index (SSEC) has staged a powerful rebound from around 1700 to a recent high of 2650, a 50%+ gain. There are a couple of investment vehicles available to US investors to get exposure to SSEC, among them, Morgan Stanley China A Share Fund (CAF) is one that dedicated to SSEC most, with 90% exposure to A Share stocks traded on Shanghai Exchange.
The CAF is a closed-end fund that invests in large cap, growth type companies, with 55% exposure to Services (among which, 34% was on Financials), and 45% to Manufacturing. This asset allocation is on constant change, you may check the latest holding on morningstar.com.
Despite its 90% exposure to stocks traded on Shanghai Stock Exchange, CAF recently dropped heavily, broke its trendline to the downside, while SSEC only dropped slightly and was maintains its up trend, see chart below
Shanghai A Share Index
Then why the divergence? The chart below is percentage change of CAF and SSEC in one year time frame.
Shanghai A Shared Index (yellow) vs. CAF (green)
Since CAF is not an ETF tracking SSEC index, but a fund that invests in component stocks there, naturally CAF is not 100% tracking SSEC. The truth is CAF follows SSEC directionally, but beta (sensitivity of change in CAF price to the change in SSEC) alternates across 1 over time. CAF has just went through an over-sensitive period (beta > 1) relative to SSEC from early March to now, it’s now switching to less sensitive mode.
Another reason for this to happen was that even though CAF is almost all about Chinese market, since it’s traded in US, its performance is affected by the US market sentiment. As S&P 500’s March- May rally ran out of steam, CAF also got affected negatively.
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Chart Reading: US Dollar, S&P 500 and Crude Oil
A few quick updates and my thoughts on the charts of US dollar, oil and S&P since I believe oil and S&P may go against each other in the coming days.
US Dollar
It turned out the higher lows in mid-March was fake bullish sign, and now it’s gathering momentum to start a huge drop.
Crude Oil
Crude price started its latest rebound in late-Feb, about half a month earlier than March lows of S&P, then it traded side ways from late-March through April while S&P continues its enormous rebound. This time frame of sideway trading turned out to be a bullish flag, and it’s breaking out to the upside just yesterday, its target this time is $75.
S&P 500
Despite all the bad news of high unemployment rates, 10 banks not passing stress tests, and pathetic consumer spending figures, S&P continued its powerful rebound from March low of 676, with 37% gain so far. It’s heading to last bear market high of 934 hit in early January, two months before the March low, coincidentally, now it’s exactly 2 months away from March low, so it’s highly possible next Monday S&P will start a big down leg, probably 20% down, targeting Nov low of 740.
A few technical commentators have already been calling correction on S&P will start soon or in progress: Carl Swenlin from Dailymarkets.com called current pattern “bearish ascending wedge” and could correct any time soon, Mike Paulenoff from MPTrader.com noted that Thursday’s market action signaled the end of up leg that started on 4/27;
The interesting question is will energy price fall with S&P during that down leg? I say no, since energy trading has de-coupled from S&P from the pattern since last November. We will likely to see, starting from next week, for more than a month, S&P will go down led by Financials at the same time energy and shipping stocks continue their rise.
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Chart Reading: USD Chart Analysis
US Dollar (3/26/2009)
S&P 500 (3/26/2009)
Spot Crude Oil (3/26/2009)
Strong US dollar seem to be correlated perfectly with poor stock market, crude oil prices. In a way that it’s almost perfect timing that US dollar peaked on the day in early March when S&P 500 hit an 12 year low and reversed track. It’s almost on the same day when crude price started to break out for real, it tried to break out several times in last 3 months, but turned back at resistance line.
It’s not illogical for this relationship: if the real production is not increased significantly, the only way to make people rich is to print out more paper money, and each unit of paper money has to depreciate more to sustain the “wealth making”, “crisis prevention”, “bail-out”, whatever you call it.
One thing is for sure, when USD starts to depreciate, and especially when government is behind this trend, it’s time to spend your cash to buy some stocks, gold, energy. For investors in stocks, this is great, let’s hope USD to depreciate more.
4/24/2009 Update:
US Dollar (4/24/2009)
S&P 500 (4/24/2009)
Spot Crude Oil (4/24/2009)
The S&P is now going thru the right shoulder of reverse head and shoulder bottoming process, and USD is doing the right shoulder before the huge crash which I estimate to start around July. So the chart indicates there will be still an small up-leg left for USD.
Even though there is a rough relationship between $USD and equity, commodity prices, what’s most interesting was the relevance between these market forces changed over time. Let’s take a look back at history:
From mid July to early September, $USD started to rally, in the mean time, stock market started to look like about to fall off cliff. Crude oil started to drop from historical high of $147. This is the prelude of the huge crash. During this time, only dollar-oil relationship worked.
From early to late September, $USD pulled back, in the mean time, stock market didn’t respond to that pullback, Crude oil did. This time, only dollar-oil relationship worked.
From late September to mid October, $USD resumed its rally, this time with stronger force than last time, reflecting the real crash had begun, we all know what happens to stock market and crude oil. During this time, both dollar-stock and dollar-oil relationships worked.
From mid October to mid November, $USD continued its rally, but with weaker force, stock market mirrored that movement, but crude oil continued its free fall. During this time, I would say both relationships worked, but dollar-stock seemed to dance better than dollar-oil.
From mid November to mid December, $USD crashed due to Fed’s dropping rate to 0, stock market responded, cruded oil kept dropping despite a small rebound in early December. During this time, dollar-stock relationship is again bettern than dollar-oil.
From mid December to early March, $USD staged a strong come back, this time rallied higher than the peak reached in November, stock market responded, crude oil didn’t, instead, crude oil reached its bottom exactly when $USD started this round of rally. Remember at this time, Shanghai stock index started to rebound. So shall we say this time, crude oil wishes more to dance with Chinese stock index than with US Dollar?
From early March to mid March, $USD crashed again due to Fed’s decision to print more money to buy T-bond and MBS, stock market responded, crude oil responded as well. During this time, dollar-stock and dollar-oil both worked again. Last time, both relationships worked was late September to mid October.
From mid March to now, $USD rebounded with a wedge shape (a precursor to huge crash), stock market shrugged it off, continued its rebound to the heavy resistance of 870, while crude oil traded sideways. During this time, let’s say both stock market and crude oil are getting ready for the huge crash of dollar.
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Invest in Oil: How to Buy Crude Oil at Spot Price?
Most energy investors need to invest in oil, but it’s impossible for average investor to buy and hold physical crude oil, and then sell it later, it’s simply too difficult. To address this problem, many investment vehicles have been created to facilitate investing in crude oil. This post talks about each of the major oil investment vehicles and their relationship to crude oil price.
Oil Prices
The often talked about oil price is not a price of a single product, but have at least two versions: spot price and futures price. Among spot price, there are two versions as well: West Texas Intermediate (WTI) Spot and Brent Spot, and WTI price is more widely used in US.
Oil ETF and ETN
Several Exchange Traded Funds were created to reflect crude oil prices, either spot or futures, so that investors can invest into this important component of commodity.
In fact, these securities are not real-sense exchange traded funds, because ETFs are supposed to hold the physical assets such as equity or commodity as underlying assets, but given the difficulty holding crude oil physically across the time, these ETFs buy and sell futures to track oil prices.
Contango and Backwardation
This way of working actually makes the price of these ETFs more complicated, the shape of futures price curve can actually affect their prices, there are two types of futures price curves: when earlier maturity futures price is lower than than later maturing futures price, it’s contango and the contrary is backwardation. Read here to learn more about contango and USO, and here about general concept of contango and backwardation.
Here is a perfect explanation of contango and backwardation from this article:
Backwardation in the crude oil futures market typically indicates that oil market fundamentals are tight, but should ease in coming months. For example, after Hurricanes Katrina and Rita, near-month crude oil futures spiked as traders fretted over supply disruptions in the Gulf and damage to refining and transport infrastructure. There were some temporary shortages of crude and gasoline in certain markets because of pipeline and refinery closures.
At the same time, most traders expected conditions to ease once pipelines were inspected and brought back online. Thus, near month futures traded at high levels relative to longer term futures–the market was in backwardation.
Contango implies that near-term oil market fundamentals are bearish but investors still expect longer-term improvement. In the late 2008 through early 2009, investors faced rapidly rising US oil inventories and an accelerating decline in global oil demand–fundamentals looked bearish.
More important, the US and global credit markets were in a state of near-total dysfunction. The lack of demand, excess supply and near cessation of business activity due to weak credit market conditions pushed down near-month futures and sent contango to record levels.
Since early this year, contango in crude oil futures markets has declined to around USD8 a barrel, still a historically stretched level. The simple recovery in contango to more normal levels accounts for about USD27 a barrel of the USD31 a barrel rally in spot prices since the beginning of the year.
With these in mind, here I give crude oil ETF and ETN a comparison.
US Oil Fund (USO)
USO portfolio: The portfolio will consist of listed crude oil futures contracts and other oil related futures, forwards, and swap contracts. USO will also invest in obligations of the United States government with remaining maturities of two years or less and hold cash and cash equivalents to be used to meet its current or potential margin or collateral requirements with respect to its investments in crude oil futures contracts and other oil interests.
USO Market Cap: $4.47 B (as of Mar. 25 2009)
USO Average Daily Volume: 34.16M
iPath S&P GSCI Crude Oil Total Return ETN (OIL)
OIL ETN: iPath Exchange Traded Notes (ETN) are senior, unsubordinated, unsecured debt securities issued by Barclays Bank PLC that are linked to total returns of market index. The iPath S&P GSCI™ Crude Oil Total Return Index ETN is a sub-index of the S&P GSCI™ Commodity Index. The S&P GSCI™ Crude Oil Total Return Index reflects the returns that are potentially available through an unleveraged investment in the West Texas Intermediate (WTI) crude oil futures contract plus the Treasury Bill rate of interest that could be earned on funds committed to the trading of the underlying contracts.
OIL Market Cap: $777.53M
OIL Average Daily Volume: 3.71M
PowerShares DB Crude Oil Double Long ETN (DXO)
DXO ETN: All of the PowerShares DB Crude Oil ETNs are based on a total return version of the Deutsche Bank Liquid Commodity Index-Oil (the “Index”) which is designed to reflect the performance of certain crude oil futures contracts plus the returns from investing in 3 month United States Treasury bills. The Long and Double Long ETNs are based on the Optimum Yield™ version of the Index and the Short and Double Short ETNs are based on the standard version of the Index. The Optimum Yield™ version of the index attempts to minimize the negative effects of contango and maximize the positive effects of backwardation by applying flexible roll rules to pick a new futures contract when a contract expires. The standard version of the index, which does not attempt to minimize the negative effects of contango and maximize the positive effects of backwardation, uses static roll rules that dictate that an expiring futures contract must be replaced with a contract having a pre-defined expiration date.
DXO Market Cap: N/A
DXO Average Daily Volume: 35.8M
PowerShares DB Oil Fund ETF (DBO)
What is DBO? The PowerShares DB Oil Fund (Symbol: DBO) (the “Fund”) is based on the Deutsche Bank Liquid Commodity Index – Optimum Yield Oil Excess Return™ (the “Index”) and is managed by DB Commodity Services LLC (the “Managing Owner). The Index is a rules-based index composed of futures contracts on Light Sweet Crude Oil (WTI) and is intended to reflect the performance of crude oil.
DBO Market Cap: $46.96M
DBO Average Daily Volume: 339,000
United States 12 Month Oil Fund, LP (USL)
What is USL? The United States 12 Month Oil Fund, LP (”USL”) is an exchange traded security that is designed to track the movements of West Texas Intermediate light, sweet crude oil (WTI). USL issues units that may be purchased and sold on the NYSE Arca. The investment objective of USL is to have the changes in percentage terms of the units’ net asset value reflect the changes in percentage terms of the price of light, sweet crude oil delivered to Cushing, Oklahoma, as measured by the changes in the average of the prices of 12 Futures Contracts on crude oil traded on the New York Mercantile Exchange (the “Benchmark Futures Contracts”), consisting of the near month contract to expire and the contracts for the following eleven months, for a total of 12 consecutive months’ contracts, except when the near month contract is within two weeks of expiration, in which case it will be measured by the futures contracts that are the next month contract to expire and the contracts for the following eleven consecutive months, less USL’s expenses. When calculating the daily movement of the average price of the 12 contracts each contract month will be equally weighted.
USL Market Cap: $3.18M
USL Average Daily Volume: 513,000
MacroShares $100 Oil Up Trust (UOY)
What is UOY? MacroShares are issued in pairs: When MacroShares $100 Oil Up are created, an equal number of MacroShares $100 Oil Down are also created.
UOY Market Cap: $7.29M
UOY Average Daily Volume: 15,000
Conclusion
If you compare the chart of WTIC to the charts of 5 oil ETFs or ETNs, none of the oil investment vehicles tracks oil price movement perfectly, the closest match to spot oil price is DXO. It reflects the fact that all the available oil investment vehicles can only mimic oil spot price movement, but none of them can perfectly track spot price.
HardAssetInvestor ran a great article in Feb 2009 to compare the USO and USL, sister funds run by same company, focusing on their pricing structure and impact of contango and backwardation, the conclusion is that USO is more vulnerable to contango situation, while USL may be newer fund to USO therefore not as liquid as USO, but USL addresses contango problem and is liquid enough to serve as a good oil spot price investment vehicle.
Sources:
How do you buy spot oil?
Julian Murdoch
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