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That time of the month—Analysts over-interpret cyclical oil price patterns

That time of the month—Analysts over-interpret cyclical oil price patterns

John Kemp recommends not get too taken in by the monthly fluctuations oil prices. He suggests another way to read the signs.

August 18, 2011 11:13 by

Oil prices have displayed a distinct monthly pattern so far this year, tending to fall in the first two thirds of the month before rallying strongly into month-end.

Front-month Brent prices have risen more than $15 per barrel since the start of the year. But sharp increases in the final third of each month totalling almost $24 so far (Jan-Jul) have offset declines in the first third (around 40 cents) and second third (just over $8) (Jan-Aug).

Good analysts should be wary of over-interpreting data, especially when the sample is so small. But the sharply contrasting performance (prices declining in the first 14 trading days of the month, then rallying hard ahead of month-end) has been marked and appears to be repeating again in August.

Two explanations suggest themselves (and are not exclusive):

(1) Bleak macroeconomic news has tended to pressure prices in the first half of each month when the major data items are released. Data releases are not distributed evenly throughout the month. The most timely and market-moving data all comes in the first 14 trading days (including purchasing surveys, US nonfarm payrolls, inflation and industrial production). The largest price declines this year have all occurred since May, when the global slowdown began to show up in data, and were all concentrated in the first 14 days of each month.

(2) Month-end prices have received support from performance valuations. Most hedge funds report performance monthly based on month-end valuations. The fund community has run a record long position in oil-linked futures and options throughout the year, according to CFTC data and exchange reports.

For the hedge fund longs, there is a natural tendency to bid prices up ahead of the valuation date to maximise returns and minimise previous losses. For the minority of investors with short positions, the final third of the month has provided an opportunity to lock in profits made earlier by covering short positions.

The result has been a clear and consistent pattern in which prices have been flat or falling in the first 14 trading days of each month, only to be walked higher, sometimes sharply so, as the month-end valuation date approaches.

Every one of the large price declines has occurred in the first or second periods each month, coinciding with the release of macro data. Conversely, there has never been a significant price decline in the final days of the month going into month end.

Several analysts have complained about the schizophrenic nature of the market in recent months, with participants torn between trading the (deteriorating) macro picture and (still strong) micro supply-demand fundamentals in the oil market.

The pricing pattern so far this year is consistent with this view. Prices have declined when the market focuses on macro data at the beginning and middle of the month, before rising when…

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