Clearly, the most talked-about financial event from last week was the "crash" of the oil market when futures contracts for West Texas Intermediate (WTI), the U.S. oil benchmark, plunged below zero and into negative territory. Before Monday, many thought this was impossible. Maybe, just maybe, it could drop to zero, effectively erasing all value. But negative territory seemed unimaginable.
However, the reason for this dramatic move was not simply the supply and demand. It was a perfect storm of timing and the underlying rules around futures contracts. Everything came to a head on Monday. WTI has a physical settlement, meaning that as the monthly contract reaches expiration, whoever holds the contract is due a physical barrel of oil. Traders, in an effort to profit from the differential, buy and sell contracts without any intention of holding them at expiration, while refiners and airlines are among those on the other side who actually want the oil.
The contract that plunged into negative territory was for May delivery. Demand isn’t expected to rebound any time soon. And with nowhere to put the oil, people were left scrambling and ultimately would do anything — in this case, even pay — to have it taken off their hands.
There are nuances, of course. For one, the May contract expired on Tuesday, meaning that trading volume was thin as it plunged into negative territory. By that point, the contract for June delivery was much more actively traded and thus a better indication of the value of oil.
Negative prices themselves are also not completely without precedent. Natural gas, for instance, has traded below zero in the past, and in the physical market, certain regional grades of crude were already trading in negative territory prior to Monday. And there were some traders who warned that, as storage filled, prices would continue to decline dramatically.
A secondary aspect of this move is the influence of ETFs in the futures markets. Traditionally the futures markets were made up of the producers of the commodity who hedge their inventories and market prices with futures contracts. you then have the speculators who provide liquidity to the market. However, due to the controlled leverage aspect of futures contracts, many ETFs are using the vehicles within their funds. Since these funds are typically long-only funds, they do not provide the liquidity that the markets used to enjoy and create price fluctuations that go far beyond the traditional supply and demand of the commodity markets.
With demand down to 1/3 of its normal levels and global storage capacity potentially full within a month, you can expect some more wild swings in the weeks ahead. So even if you think you can buy oil at a "discount" right now, it would be best to stay away until volatility subsides or you are a professional trader and have stops in place.
Where the Major Indices Stand Today
The Dow Jones
Close price on April 24, 2020: 23,658
Gain/Loss for the week: -2.07%
Prior date of price range prior to pandemic: January 10, 2019
Value Loss Period: 470 Days
The S&P 500
Close price on April 24, 2020: 2,829.50
Gain/Loss for the week: -1.41%
Prior date of price range prior to pandemic: August 26, 2019
Value Loss Period: 242 Days
The Nasdaq 100
Close price on April 24, 2020: 8,769.00
Gain/Loss for the week: -0.45%
Prior date of price range prior to pandemic: January 8, 2020
Value Loss Period: 107 Days
Overall it was a down week for the major indices. The Nasdaq performed best with a loss of -0.45%, followed by the S&P 500 with a loss of -1.41%, leaving the Dow performing the worst with a loss of -2.07%. While the primary trends are still up, resistance levels are closing the price gap which could open things up for another down move.
As we've stated before, it's a fool's game to time the market or to try and jump in and buy at a discount. A properly built portfolio with appropriate levels of diversification, volatility controls, non-correlated assets, risk/return biases, and void of emotions will help ensure you are positioned for the longterm success.
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