It is often tempting to think that the “f” in financial markets stands for fickle. Back in January when we last wrote about crude oil, all the chatter was about the price sliding below USD 20 p/b because of concerns about oversupply and faltering demand in the wake of more subdued global economic growth, notably China. Now, barely three months later and with the crude oil price having rallied all the way up to USD 45 p/b the focus has shifted to a new price target: USD 50 p/b. Admittedly the global economic environment has brightened, or perhaps better put, has become less dim in the intervening period but arguing that the near doubling in the price of crude oil over such a short time-frame is solely attributable to an improved fundamental backdrop is a tough sell. Clearly there is something else that has contributed to the change in the crude oil price… and that something is sentiment.
The chart below shows the evolution of crude oil sentiment (orange line) versus its price (black line) since 2014. What is clearly discernible is that even though the eventual bottom in the price of crude oil occurred around the turn of this year, it was the halving of the crude oil price from USD 100 p/b to USD 50 p/b observed between July and November 2014 that had the greatest negative impact on crowd sentiment. Indeed, since November 2014 sentiment towards “black gold” has consistently moved higher over this period, albeit with some notable fluctuations.
Exhibit 1: Crude Oil Sentiment and Optimism versus Price
Source: www.amareos.com
This “non-confirmation” signal, to borrow the language of market technicians, was evidence that something was changing in relation to investor perceptions about crude oil even if it is was not evident in the price. Indeed, as we wrote back in January[1], the sentiment indicators constituted,
“a significant warning to investors not to chase the crude oil price lower, no matter how tempting. In fact, the smart thing is probably to look for cost effective ways to play the upside over the medium-to-long-term”.
That was then, what about now?
Referring back to the above chart, sentiment towards crude oil has increased over recent weeks to levels last seen when crude oil was comfortably trading above the USD 100 p/b mark. While this level is not particularly elevated relative to history (a reading of 0.5 is only slightly above the long-run average), having increased relatively sharply it is a warning sign that perhaps things have gone “a bit too far, too fast”, especially as optimism[2] towards crude oil (red line) has also increased markedly over the same time frame.
In addition, the pattern of individual emotions expressed towards crude oil that we also monitor are distinctly less negative than we observed in January: sadness having declined significantly, while trust – a positive emotion – has increased[3].
Exhibit 2: Crude Oil Emotional Polar Map
Source: www.amareos.com
In aggregate, the sentiment and emotion metrics suggest at a minimum a period of consolidation for the crude oil price is likely and that just as chasing the crude oil price lower back in January proved not to be a winning strategy neither will positioning for a much higher move up in the crude oil price now.
Finally, while we have suggested that fundamentals have not been the sole contributing factor behind the rise in the crude oil price over the past quarter, they cannot be ignored altogether. For example, the positive correlation between the crude oil price and the performance of global equity markets has persisted, with the latter having also rebounded both in terms of price and sentiment (see heat map below). This apparently symbiotic relationship is suggestive of a common casual factor; namely rising expectations that the world’s leading central banks were prepared to keep the monetary stimulus spigot wide-open in support of economic growth.
Exhibit 3: Global Equity Market Sentiment Heat Map
Source: www.amareos.com
Ironically, this positive impetus could be undermined because of the rebound in crude oil price that has already taken place will significantly boost headline CPI inflation rates over the course of the next 12 months (adding a full percentage point or more).
Of course, central banks could choose to look through this inflationary effect and keep monetary policy settings very accommodative, but there is clearly a risk they do not[4], especially if, at the same time, investors start to demand higher interest rate premiums to compensate for higher anticipated inflation. Should this situation arise -or even be suspected as likely to occur – worries about global economic growth, and by extension demand for crude oil, could quickly return and this would act as a depressant both on sentiment and the price of the black stuff.
*Sentiment Analytics are based on MarketPsych indices.
[1] See: https://amareos.com/blog/2016/01/14/hyperb-oil-e/
[2] Whereas sentiment is an aggregated measure of contemporaneous positivity or negativity expressed towards a given asset optimism is an aggregated measure of future positivity or negativity expressed towards a given asset.
[3] Interestingly, anger remains elevated. Ongoing evidence of dissatisfied bears maybe! To compare this chart with the earlier version please follow the link in footnote 2 above.
[4] For the avoidance of doubt, we do not believe the BoJ’s surprise decision this week not to inject further monetary stimulus reflects such concerns.
