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VIX base case
Here are the scenarios of note:
Bull case in 2016: VIX in upper 20s-30s
- US markets re-base: hyper-inflation from the seven-year bull market brought on by the Fed’s QE programs filters out, leading to a sharp equity selloff.
- Manufacturing and industrial productions prints remain in contraction or at decade lows.
- Employment starts to feel the squeeze and slows.
- CNY ‘surprises’ the markets with a sharp devaluation.
Bear case in 2016: VIX back in high (even low) teens
- Improvement in US earnings - breaking the three quarters of negative earnings growth will help stability.
- Improving ISM numbers in the US – manufacturing out of contraction.
- China showing signs of stability and increases demand for global imports.
- CNY NOT ‘surprising’ the markets with a sharp devaluation
In short – My view is the VIX will average above the yearly average of 17.3 (past 25 years) in 2016.
What drives this call will vary over the year – however, it is currently fear driving the oil markets.
The oil trade
I have been particularly keen on trading Brent over the past eight weeks. The macroeconomics of oil are very compelling for those with a short-term view. Again, forming a solid base about the top-down views has made the short call in Brent the correct one.
- Geo-political tensions and OPEC inaction (on the brink of collapse in my view)
- Non-OPEC non-US producers continuing to maximise output
- The EIA showing stockpiling at record levels
- The onshore shale-gas trade seeing rig counts down but not collapsing
- Chinese demand not absorbing supply
The demand/supply equation for oil is still skewed to the right and sees breakeven points putting the equilibrium price well underwater.
Be aware: A possible alteration to my macro view involves rumours that Russia and Saudi Arabia are in discussion to cut production, which was reported by the Iraqi oil minister overnight. Oil settled up 3.6% on the rumours and this is the risk to my Brent trade. However, the chart is showing several things:
RSI’s have not hit 60 since September and each bounce off the ‘oversold’ level of 20 has only seen the strength indicator moving back to ‘natural’ rather than signalling a buy with conviction trade.
The current pop suggests short covering and the moving averages are signalling that prices of US$30 or lower are a more likely scenario in the coming few weeks. The chart shows the momentum is still to the downside.
However, buying is strong at the upper end of US$26 a barrel. That buying also coincided with oil volatility hitting a record peak last week, the highest level since the OIV index was first created.
Note it is still elevated and feeds back into my macro base case around the VIX in general.
Brent trade idea
I’m looking to sell into strength up to US$35 a barrel. My reasoning? Expectations of inaction from OPEC are keeping supply at current levels and Chinese New Year is seeing demand slow to a standstill.
I see having a limit at US$27 a barrel as advantageous, as level buying will come in, plus a stop loss at $35.50 a barrel to limit the possibility of macro intervention.
I have a short view here and will reassess the trade in mid-February when China is back from New Year celebrations.
Ahead of the Australian open
The ASX looks like having a flat open. However, the oil pop overnight and the fact US markets have had two reasonable nights mean leads for the Australian session are on the up.