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Trader's Corner
This week’s Trader’s Corner cites reasons for incorporating technical analysis in your propane-buying plan.
Highest crude inventory since 1931
On Thursday, the U.S. Energy Information Administration (EIA) released the fundamental data for crude and products. The data is always a day later following Monday holidays. Crude showed a build of 3 million barrels, taking U.S. inventories to the highest level since 1931. That is a pretty amazing fact.
So how do you suppose the market reacted to this record-setting number? If you think prices dropped, you would be wrong. Instead, the market responded to a 1.5-million-barrel draw in gasoline inventories, when a slight build was expected, causing crude prices to go higher.
So, with the highest crude inventory on record in more than 75 years, crude prices went higher on a gasoline draw. What was more intriguing to us was a draw in gasoline inventories shouldn’t have been unexpected. It’s been a cold winter and weather has been moderating, so driving activity is starting to pick up. Plus, you would think that analysts would have expected gasoline use to really kick as folks filled up for the Memorial Day weekend. But that is just our perspective – keep that in mind as you read this article.
Now by Friday, the market did begin to focus on that crude inventory and crude was sliding through late-morning hours as we were putting this piece together.
That wasn’t the only conflicting market response during the week. The energy markets have been concerned about the Fed cutting back on the stimulus plan. As not-so-good economic reports came out during the middle of last week, crude markets rallied. Weaker economic outlooks generally are not good for energy prices, yet the market took that data to move higher.
The reason is the current rallies in commodities and equities have primarily been driven by the easy money policy of the U.S. Federal Reserve and other central banks. The weak data increased the chances the Fed would keep the stimulus activity going. In this case, a negative was really a positive.
By Friday, the market decided the negative was really a negative, not the positive negative it thought it was on Thursday. Now that will make your head spin; somehow it feels we are studying physics rather than propane.
That reminded us of a quote you often hear regarding the markets: “The market can stay irrational longer than you can stay solvent.”
Understanding price patterns
One of the things we do is a continual analysis of price patterns. This type of analysis in its basic sense is called technical analysis. It comes down to the idea that each day’s price has all of the known information factored into it by the market participants. The key to the analysis is identifying trend changes – markets that are too high and markets that are too low.
Understanding price trends can help you make better buys than simply establishing an arbitrary buy number. If the market has slid to a price at which you would buy winter supply, it is possibly in a downtrend that will carry prices even lower.
The better strategy is to buy once the market moves higher after having been in a downtrend. If we simply pick a number and ignore the technical trend, we run the risk of stepping in too early, which works against our goal of making sure we have competitive supply.
The one caveat to that is we always believe you buy (regardless of any analysis or fundamental study) when you are truly hedging and that buy guarantees an acceptable profit for your company.
Technical analysis is used to help us refine our buying activity when we are acting more speculatively. For example, we are buying product that we know we won’t sell for months down the road and do not have a sales agreement establishing the price we will receive.
Watching price patterns and understanding them can give you better insight to the market than just fundamental analysis alone. We see things like double tops, the golden cross, head and shoulder patterns, doji stars, support and resistance levels from Fibonacci retracements and much more. This greatly helps in the evaluation of the current trend and helps us identify when market tops and bottoms are potentially forming.
We have propane price histories to before 2001. We have back-tested many of these tools to check their effectiveness. The results are so clear that we often make this challenge: “Bring us your past prebuy entry points and allow us to back-test them against these tools to show if the buy was good or not!”
Why did we start using these tools?
During our annual hedging seminars, we have a section where we group three to four people, forming fantasy propane companies and instructing them to apply hedging concepts learned in the class. We provide them with the price history of an actual year, which they can only see one day at a time.
We also provide the attendees basic technical tools (remember technicals assume the price reflects the sum knowledge of all market participants), but they are not given the fundamental details that were occurring in a particular year. In other words, they are making decisions strictly based on technical analysis.
After evaluating the exercise, it became apparent the teams were doing a good job of buying. The purpose of the exercise is to prove that the proper use of technical analysis, followed by applications of basic hedging tools driven by what the technical analysis reveals, can greatly improve the probability of making good propane buys.
When we first started this company, we primarily used fundamental analysis in formulating our recommendations to clients. But, time and again, we found the market appeared to move irrationally given the prevailing fundamental backdrop. That fact drove us toward incorporating technical analysis into our evaluation process. Using technical analysis within the framework of fundamental analysis has proven to be much more successful than making decisions on fundamental analysis alone.
Why is this the case? Because the price of propane is set by all market participants. No one participant has all of the information, nor does all market participants interpret common information the same. So that means the market almost always seems irrational at one time or another, if not all the time, to any given participant in that market.
Technical analysis forces us to acknowledge the corporate view of all market participants rather than rely solely on our singular view. Our view is no doubt based on much less information than the sum knowledge of all market participants. To that limited knowledge, we apply our own filters or paradigms, which may further limit our ability to be “in tune” with all other participants in the market.
Technical analysis helps us get in flow with the masses, even when the masses are being totally irrational – at least in our view.
Call Cost Management Solutions today at 888-441-3338 for more information about how Client Services can enhance your business, or drop us an email at info@propanecost.com.
WEEK IN REVIEW
Crude moved lower on weak fundamentals and the possibility that the U.S. Federal Reserve could end or reduce its economic stimulus later this year.
Propane fell with crude and on a bearish EIA report.
We went into the week bearish, with neither crude nor the latest inventory data supportive of propane.
LAST WEEK'S DAILY HIGHLIGHTS
Monday: Markets closed for Memorial Day.
Tuesday: Both West Texas Intermediate (WTI) and propane posted modest gains to start the week. The propane hubs followed crude but came off highs to close at +0.7 percent for Belvieu and +0.3 percent for Conway. WTI had a 0.9 percent gain to start the week, gaining strength from Middle East tensions, positive economic news and traders looking ahead to the Organization of Petroleum Exporting Countries meeting.
Wednesday: Both hubs ended up posting negative numbers, but not quite as severe as WTI. Belvieu dropped 1.5 percent and Conway was down 0.7 percent, while crude led with a 2.0 percent drop. Lower-than-expected growth numbers in the Chinese economy was the main factor for the drop in the markets. The International Monetary Fund cut its growth projections for China from 8 percent in 2013 to 7.75 percent. Furthermore, it also cut the growth expectations in 2014 from 8.2 percent to 7.75 percent.
Thursday: WTI crude oil closed in the positive numbers after showing weakness early. Despite a 3-million-barrel build in crude inventories, crude rose on an unexpected gasoline draw and a weaker dollar. Limiting the gains in crude were the weak U.S. economic data and news that the Federal Reserve could ease up on its stimulus program. U.S. crude stocks hit a record high of 397.55 million barrels, which is the highest level since 1931.
Friday: Both hubs lost value this week, as Belvieu closed the week down 1.1 percent and Conway was down 2.3 percent. Belvieu moved down 2.25 cents and Conway was down 2.125 cents. Crude oil weakness is coming from weak U.S. data and EIA inventories from Thursday. Consumer spending was down 0.2 percent in April after an expectation of a 0.1 percent build.
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