The Euro continues to lose strength against most of its major counterparts before manufacturing data scheduled for release next week is expected to show declines for the Eurozone as a whole.  Yesterday, the main story for the region was the Treasury Bond Auction in Italy failed to inspire much interest and this is doing little to prop up equity markets and the EUR/USD, which is now trading below 1.2950 and the EUR/GBP now seen below 0.84.

In the UK, macro data will come in the form of the Nationwide House Price Index but with holiday themes continuing, there will be no major corporate earnings reports released today.  In US equities, S&P 500 futures are pointing to a moderately lower open and most of the trading activity will be guided by the NAPM-Milwaukee Business survey, released during the New York session.  Corporate releases are mostly second-tier, with Cano Petroleum Company and Ark Restaurants scheduled to report.

US equity markets did see a great deal of volatility in some sectors, with one of the main stories seen with AMR Corp., which dropped nearly 40 percent during the aftermarket session on news that the New York Stock Exchange plans to delist the company in the first week of 2012.  Sears Co. was also slightly lower after a long term credit downgrade from Fitch (from B to CCC).

Yesterday’s macro data out o the US was positive, with Pending Home Sales for November reached the highest level since the middle of 2010.  This helped home builder stocks (such as Pulte Group and Lennar Corp.) move higher on optimism that the housing market has found its bottom.  European stock futures in both the DAX and CAC are pointed to a mostly unchanged open.  Regional trading will be guided today by Retail Sales out of Germany and the corporate earnings of Mistral Media.

Overnight, Japanese releases showed that manufacturing productivity, in the form of the PMI report, which rose to 50.2 in the month of December (up from 49.1 previously).  A similar report was released in China, with the number showing an unchanged result at 48.2.  South Korean CPI showed a rise of 4.2 percent for December, which was higher than the market consensus and well above the target range for the Bank of Korea (which is suggestive of future interest rate increases).

Technicals:

The USD/CHF is trading at a very key resistance turned support level in the 0.9390 region.  The initial upward break here pushed prices above 0.9450 but the current strength in the CHF could see prices back into the lower range.  This downside break is supported by the MACD crossing over into negative territory, and a close below Fibonacci support will target the lower end of the previous range.

The FTSE is grinding through moving average resistance en route to a test of the upper end of the daily symmetrical triangle.  An upside break here would be a very bullish signal but the key resistance comes in at 5630.  A break here signals a reversal in the latest downtrend.  A failure targets Fibonacci support at 5300.

A few years ago, most retail trading was concentrated in shares and currencies. Commodities and precious metals like oil or gold were for experienced and professional traders with large portfolios. Most of the action in the commodities markets was carried through futures exchanges, and trading was in large lots.

Nowadays things are changed. Commodities are traded everywhere and spread betting traders don’t miss a chance to have some oil lubricating their portfolios. Trading occurs in small fractions and a spread better can place trades of just 50p per point at Finspreads or City Index.

Spread betting providers usually offer two flavours of oil to trade on: Brent Crude and WTI Crude or Light Sweet. There are other types of oil but those two are the most important and the ones you are most likely to find inside spread betting.

Brent Crude comes from the North Sea and is a blend of several types of crude from the region. It is responsible for something near 70 or 75% of all oil trades around the World. Nevertheless in the US, WTI is used as reference instead, being cited in the news, TV, and all information sites.

WTI stands for West Texas Intermediate. This is high quality oil with very small quantities of sulphur, making it sweeter. That is why it is also known as light sweet oil.

The difference in quality makes WTI stand out but it does not mean WTI is more expensive. In fact, at the time of writing, WTI is cheaper than Brent. The reason is because quality is just one of the items that are accounted for when the price forms. There are many other variables to account for. Historically they have prices that on average don’t differ much from each other and when the spread widens, it tends to revert back with time.

Spread betters can trade Brent Crude, WTI Crude, and the difference between the two. One traditional market in which speculators like to trade is the Brent-WTI spread. That is basically the difference in price between the two: Brent Crude price less WTI price. It is similar to being long the Brent and short the WTI. Because this spread tends to zero, traders like to place trades when it widens too much or when they believe there are reasons for the price of one type of oil to move quicker than the other.

The level of economic activity and, in particular, future prospects for growth are main drivers for oil prices. If the world economy is set to expand quickly then more oil will be needed to produce and thus the oil price is pressured up.

Regional Differences in the Oil Market

There are several factors influencing oil prices and that may account differently for each type of oil and thus to change the Brent-WTI spread. Regional supply, disruptions in supply and natural disasters all affect unequally the two types of oil. Hurricanes affecting the Gulf coast usually tend to elevate WTI price. They cause disruptions in the regions and led to price increases. Regional demand is also key for prices. WTI is more often seen inside the US while Brent more in Europe and in the developing World. If GDP growth in US is better than Europe in general, WTI may increase faster than Brent. When China is growing faster, maybe Crude can be pressed higher.

Politics affects the economy and thus the oil market. This year we assisted to instability in the MENA region. Problems in Libya, Egypt, Saudi Arabia, and many others, led to some disruptions and to expectations of future disruptions that weighted more on Brent than on WTI.

Pipelines and the general infrastructure to conduct oil to the final client or to refineries are also of crucial importance. In the US there are several pipelines connecting the Gulf Coast up to Canada and to conduct oil around the country. This year there was an inversion of oil direction inside the pipeline infrastructure that resulted in an accumulation of oil at Cushing, Oklahoma, pressing WTI price down that led to a record Brent-WTI spread.

In order to know the direction the Brent-WTI spread will take, a trader needs to evaluate all the factors that may create regional differences and change the demand-supply equilibrium differently for both kinds of oil.

Historical Relation Between Brent and WTI

It is now time to have a look at some data to better understand the relation between the two types of oil.

The following table shows correlations, price changes and the spread for Brent and WTI for the period between 2005 and 2011. The dataset ranges from 20th March 2005 and 20th December 2011. This way, data for 2005 and 2011 does not include the full year.

The correlation between Brent and WTI is high although variable across time. If we look at annual price changes we clearly see that when the price changes in one direction for Crude then it is expected that the price for WTI changes in the same direction and with similar strength and vice versa. Regarding the Brent-WTI spread, it is less than 2.00 on average but this year it widened to an average of 15.44.

The above chart shows that Brent and WTI move very closely but Brent jumped a little more in 2011 creating some kind of a gap between the two. The chart below shows that the spread touched near 30 this year but started decreasing since that point and currently sits below 10.

Start Trading the Brent – WTI Spread

Now that we have identified the main drivers for price in the oil markets and after studying the relation between Brent and WTI, it is time to use the information and knowledge to place spread trades.

As we have learned, you should have in mind that: 1) the spread depends on the evolution of each oil market separately, and there are several regional factors that affect it as we have seen, and 2) the spread tends to revert back to near zero after widening.

After studying the market, it’s time to place the trades. Capital Spreads, for example, allows you to trade directly on the Brent-WTI spread. Others that don’t have such a market still allow you to do the same. Just stake the same amounts on each oil market but in opposite directions and you will get the same position as you would with a spread market. It’s that simple. Nevertheless, there some disadvantages deriving from the simulated position: it will require you a larger margin requirement, because the system will not offset the risks of the long with the short position; it will cost you more in terms of spreads; it will require more attention, because you will need to monitor two positions instead of a single one; it will require changes in stop levels, because you can’t set a stop for the whole portfolio losses but just for each product.

Equity markets in Asia are showing losses for the third day in a row and this is putting upward pressure on both the US Dollar and Japanese Yen, with EUR/JPY reaching 10-year lows overnight and European bond yields reaching new highs.  Despite this diversification away from risk assets, Gold is continuing its weekly declines but this is seen mostly as a result of US Dollar strength (as gold is priced in US Dollars).

The MSCI Asia Pacific Index was also lower and this latest move brings the yearly decline to 18 percent.  Macro data for the day showed that manufacturing production in South Korea was down for a second consecutive month and today the focus will be placed Italian business confidence slumped and Pending Home Sales from the U.S. (both of which are expected to show declines).  The Eurozone debt crisis continues to weigh on trader sentiment and this is currently being exacerbated back a lack of liquidity and trading volumes.

In the US, 10-year Treasury bonds rose to 1.93 percent as markets are anticipate that initial jobless claims also increased during the previous week.  The consensus is looking for a rise to 375,000, which would be a reversal of the previous positive trends that have been in place since the summer.  Negative news in the housing data could also contribute to lower equity markets during the session, especially given the elevated levels we are seeing in the Dow Jones and S&P 500.

This week’s Italian bond auction will complete tomorrow with sales of 8.5 billion Euros with maturity dates ranging from 2014 to 2022.  At time of writing, 10-year treasury yields in Italy remain in the 7 percent region after the 9 billion Euro Six-month bond auction yesterday, and the lack of buying interest is still seen as an obstacle for equity markets.  The next Merkel-Sarkozy meeting will take place on Jan. 9^th to discuss the next strategies for the European debt crisis.

Oil has dropped back below the psychological 100$ level, seeing a 2 percent drop during the previous New York session.  Part of the decline can be explained by the gains in the US Dollar, and part can be explained by the lower demand forecasts in manufacturing productivity but another factor to watch is the change in inventory levels, which rose to 9.57 million barrels.  We will see more data with regard to this today, as the US Energy Department report is expected to show inventories dropped by 2.5 million for the week.  If the forecasts are true, we expect to see a modest rise in Oil during the trading day.

Technicals:

The EUR/JPY is falling through some very significant long term support levels, so we will pull out to the monthly charts to see what exactly is happening with the pair.  The falling wedge has broken all historical and Fibonacci support levels ahead of 88.80, so this is now the next level to watch on the downside.  Shorter term, however, indicator readings are over extended and should provide some bounces on the smaller time frames.

The DAX is operating within the confines we have mentioned previously and prices are now pressuring support at 5770 after failing at 5930 resistance.  A daily close below support targets the bottom of the daily symmetrical triangle and most likely a deeper retracement back into the mid 5300s.

European equity markets are seeing declines in volatility but still managing to post gains for the week ahead of the next Italian Bond auction where nearly 20 billion Euros in Treasuries will be made available.  In the previous sessions, US markets closed relatively unchanged while declines were seen throughout Asia.  The Stoxx Europe 600 is showing gains of 2 percent for the week (but showing declines of 12 percent for the year), and trading above the 240 mark, fuelled by positive macro data from the US and a lack of negative headlines relating to the Eurozone debt crisis.

The main story in markets now is the continued lack of market participation and thin trading volumes, which is making price activity vulnerable to large swings into the Italian bond auction.  Stock exchanges in both England and Ireland are closed today but recent headlines have centered on the region’s job market which is now showing its lowest employment levels in nearly 20 years.  Some analysts projections have suggested that the total number of employed will drop by 125,000 next year.

In Greece, attention will start to turn to the national elections that will be conducted in April and so the current leadership (headed by Prime Minister Papademos) will look toward a goal of reaching loan and budget agreements in the next few months.  The added timeframe will give markets an opportunity to start assessing macro data releases (rather than simply trading off of erratic news headlines), so the most likely result here is that this alleviates some pressure on the Euro and on regional equity markets.

In commodities, Copper dropped in the London session on news that Japanese industrial production is showing slowing momentum and overall demand expectations continue to see weakness.  In individual stock shares, Deutsche Bank AG and Commerzbank dropped 2.5 percent as markets are weary of the financial sector ahead of the next Italian bond auction.  Tesco was up 2.3 percent (showing the best performance in the Stoxx 600) as defensive stocks and household goods continue to trade at elevated levels into the close of the year.

Technicals:

The EUR/CHF is trading at the lower end of its daily range with prices now near the support level at 1.2160.  The recent drop is suggestive of a test into the low 1.20s and we will need to see a break of both the 100 and 200 period EMAs as well as the 38% Fibonacci retracement near the breakdown point at 1.2270.  Ranges are really starting to tighten in this pair so we are expecting breakouts to have significant follow through once they occur.

The FTSE 100 continues to be caught in its longer term symmetrical triangle, with prices grinding through moving average resistance and the MACD indicator starting to flatten out in neutral territory.  The higher highs, though, are encouraging and it is looking likely that the eventual triangle break will be to the upside.  A break of support at 5280 reverses this bias and puts a downside triangle break in play.

Equity markets are lower on Tuesday (snapping a three day bullish run) after the Bank of Japan monetary policy meeting minutes produced a pessimistic policy statement and markets have started to anticipate a negative response to the Italian Treasury auction later this week.  Risk assets were lower with high yielding currencies selling off and most commodities pushing lower in the session.  Trading volumes remain thin even with the US stock markets re-opening, as the UK, Hong Kong and Australia are still closed for holidays.

Risks cited by the Bank of Japan were largely predictable, with the European debt crisis and the continued strength in the Japanese Yen (JPY) seen as the main areas for concern.  Other macro releases out of Asia came with disappointing consumer confidence survey out of South Korea and Chinese industrial profit data.  Later today, the macro focus will center on the US Home Price Index and the market is expecting declines for these figures as well.  After this, the next big event risk will be seen with this week’s Italian bond auction, where 9 billion Euros in 6 month treasury bills will be sold during the Wednesday session.

End of the year tallies for the major global stock indices are showing that markets have extended losses, for the most part, as the MSCI Asia Pacific Index is down 17 percent for the year, while the Stoxx Europe is down 12 percent.  These are the worst figures we have seen since 2008 but the one bright spot (if we can call it that) is the S&P 500, which is set to close the year with a 0.6 percent gain.

On the whole, trading volumes remain thin and this is leading to a slowdown in volatility, but there is a possibility that this could reverse at any time and, if this does occur, the catalyst could very easily be results of the Italian bond auction.  Bond yields in Italy rose to nearly seven percent last week for the ten year notes.  Seven percent seems to the “magic number” of sorts as this is the area where Greece, Ireland and Portugal began requesting bailout loans, so any increase in this for the Italian treasuries will not be viewed favorably by equity markets.

As far as data estimates, the market is expecting the US Home Price Index to show a drop of 3.2 percent for the month of October (on a yearly basis) and if this is met, it will be the slowest rate of decline since the beginning of the year.  For the consumer confidence survey, the consensus is looking for a rise to 58.6, which will be the highest level since the middle of this year.

Technicals:

The AUD/USD is flattening out at the upper end of its recent range and resistance is now seen in the 1.02 region.  A break here will see a moderate drift higher but the real level to watch comes in at 1.0330, which is a major long term Fibonacci level and project prices to rise much higher in the long term view, targeting a full retracement of the previous Fibonacci move.

The DAX is now trading in a very tight range defined by resistance at 5930 and support at 5770.  We are currently caught in a longer term symmetrical triangle, so the direction of the first range break will likely be a precursor for the way the wider triangle breaks as well.  Wait for a break and daily close above these levels before establishing new positions.