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Many times I have commented about the impact of algorithmic or technology based trading, the trading strategy based on momentum rather than analysis.  In my view the basic tenant of this philosophy is past performance is indicative of future performance.

Oil is perhaps one of the most volatile asset classes in 2016.  On January 1 crude was around $42/barrel, plummeted to around $26/barrel by early February and then surged to about $52 in early June.  Oil then fell about 22% falling last week to about $39.

Yesterday Bloomberg reported short position in West Texas Intermediate crude rose to the highest level since 2006 for the week ending August 2.  As noted above, oil has plummeted about 22% in 6 weeks, perhaps the result of massive shorts emanating from the perceived impact of a higher dollar and greater inventory levels  (Note:  inventory levels fell for a record nine consecutive weeks and 10 out of the last 11 weeks).

Oil today is around $43, up about 10% from late last week.

Will oil trade lower for the myriad of well-known reasons, or will prices rebound back to $50?  Bloomberg writes there are only three times short interest has been this great and crude rallied between 29% and 95%.

Bloomberg also commented the short term volatility is intense, violent volatility that is rarely experienced by this degree.

Last week I compared the 2016 oil market to that of 1999, asking rhetorically will oil now rally 50% as it did 17 years ago?  Bloomberg has perhaps answered this rhetorical question.

In 1999, the periodical The Economist forecasted oil was going to surge because of supply disruptions.  Oil did rally, the result of greater economic growth and reduced capital expenditure programs.

It is now common knowledge western oil producers have slashed their capital expenditure budgets by a record $350 billion in about 18 months.  For the first time in at least three decades most of the seven “oil majors’ have not replaced their oil pumped in the prior year.

Yesterday it was reported OPEC—led by Venezuela, Ecuador and Kuwait—has called for an informal meeting to curb production.   Iran and Saudi Arabia has already announced their intentions of not lowering production thus suggesting any calls are toothless.  Russia announced however indicated that they may attend this “informal” meeting.

I think production is going to decline regardless given the lack of sovereign funds for infrastructure investment and geopolitical unrest, aka Nigeria and Libya.

If oil does rally 40% or to around $60/barrel by year end, what will such an advance do to inflationary expectations?

Markets were relatively uneventful yesterday for the exception of oil.  What will happen today?

Last night the foreign markets were up.  London was up 0.32%, Paris up 0.61% and Frankfurt up 0.80%.  China was up 0.71%, Japan up 0.69% and Hang Sang down 0.13%.

The Dow should open flat.op

The 10-year is up 3/32 to yield 1.59%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.