ASH BENNINGTON: Welcome to the Real Vision Daily Briefing. It's Tuesday, February 22nd, 2022. I'm Ash Bennington joined today by Real Vision's own Weston Nakamura. Tony Greer is on vacation and will be back tomorrow. The top story today, the events in Ukraine. Russian troops have entered the Donetsk and Luhansk breakaway Republic in the Donbas region of eastern Ukraine bordering Russia.
Today in a news conference at the White House, US President Joe Biden called the actions "the beginning of a Russian invasion of Ukraine", the flagrant violation of international law. The Biden administration has also announced sanctions on Russia and to Russian banks and individuals and stated that Russia would pay "a steeper price" if the events continue to unfold. Germany has declined to certify the Nord Stream II pipeline between Russia and Germany effectively halting its implementation.
Obviously, today is not surprisingly a risk-off day in US equity markets. Let's run through some of the prices. Dow Jones Industrial Average, the biggest loser today of the major equity indices, off 1.42%, nearly 1.5%, closing down at 33,596. S&P 500 off 1.01%, closing out the day at 4,304. NASDAQ also off 1.23%, nearly 1.25%, closing out the day at 13,381.
Energy markets rallying today. WTI, West Texas Intermediate, crude trading right now at 92.35, Brent trading at 96.36. Brent, of course, the international price of oil, WTI, the price at Cushing, Oklahoma, the US price for oil. Weston, obviously a risk-off day. I know that you're looking at these markets very closely, what do you think of this price action?
WESTON NAKAMURA: Yeah, so this is a very good example of why you need to be very aware of cross asset markets, regardless of if you are a single asset trader or an investor, or what have you. I tweeted about this yesterday, but you need to know essentially what is moving the markets because at this current moment, we have obviously the Russia-Ukraine headlines, and by headlines, I mean their machine gunning out like every 16 seconds.
At the same time, you also have questions about whether the Fed is going to remain as hawkish as the consensus, and you have a whole bunch of other-- and a number of things. It's hard to know what is moving what and what is not moving what, so that you don't just fall asleep, trail off in a relevant direction.
ASH BENNINGTON: Yeah, also obviously important to point out, this is very much a murky type of situation, the fog of war, as the phrase goes very much in effect here. There seemed to be some disagreement earlier today about whether the Biden administration was officially calling this an invasion. Obviously, this situation, very fluid, fog of war in effect, trying to piece these things together.
Weston, what are you making of the things that we can see which are the prints that we're getting on the screen right now in commodities? I mentioned WTI and Brent at the top of the show. Also, not gas up about 1%. This is NYMEX natural gas changing up 1% on the day, now at 448. That's dollars per mega BTU?
WESTON NAKAMURA: Yeah, sure. Actually, before we get into commodities, if I could just run through today's price action in particular, because I have charts. Brian, if you go to chart zero. Yesterday, US was closed, and that was a very interesting time to look at markets because you have this major risk-off, global risk-off from Asia to Europe. We're talking 2%, 3% down on indices and all that, and at the same time, you have the US indices, the futures markets and the Treasury markets and the Treasury futures markets is closed, so you're feeling around the dark as far as US assets are concerned.
If you want to get a gauge of what the general macro sentiment would be, you can look at things like the Euro/ruble cross rate, which is something that you and I had discussed last time, to see if this is something that is moving in line with European equity markets, for example. And if they are, you know that this is a risk-off move that can be attributed to specifically the Russia and Ukraine headlines, or you can match them up with a December 2022 Eurodollar futures contracts to see if it's like that.
But today was very interesting because-- the first part you're seeing right here is basically month to date. And you can see the latter half of that chart really has been a market that's been driven by these headlines coming out of Ukraine and Russia.
ASH BENNINGTON: Let's explain precisely what we're looking at here. You have Euro/ruble inverse. This is the flip rate, basically the reciprocal rate where you're seeing that chart representing Euro strength, ruble weakness, and S&P e-minis. These are the CME traded E-Mini S&P 500 futures showing, obviously, a decrease in the price of the S&P 500. And those things obviously, very tightly correlated on your chart.
WESTON NAKAMURA: And the reason I'm using the e-minis is because if I'm just using like SPX or SPY, that's only from 9:30 am Eastern to 4 pm. But e-minis trade not round the clock, but they trade throughout Asia, they trade throughout Europe. And therefore, you can match it up better with FX which is a 23-hour market. And then the Euro/ruble, I just did it an inverse because these are [?], and this is basically like that white line going down, that's the ruble getting weaker versus the Euro, and up is the opposite.
That's basically what's been the trend over the last two weeks or so. The next chart, though, is this intraday today. It's very interesting, because you saw Asia down. Japan, Hong Kong down 2% on the day, Europe too was getting hit pretty-- or e-minis are getting hit pretty hard during the European session and it looked like even the S&P was going to open down, potentially close to 2%, but it didn't.
And the reason why is because if you go to the next chart, you see that V-rally there right in the middle, that is the DAX index, which I just used as a proxy for just European equities. And you see that from cashflow.
ASH BENNINGTON: Yeah. DAX, for those who don't know, obviously, is the German Stock Exchange.
WESTON NAKAMURA: Yeah. At European cash open, Europe got beaten up really bad over the last few days. Again, US was closed yesterday, and then at European casual, yeah, the indices open down, but after that cash open, from cash up and forward, it's a pretty big rally, and that lifted risk assets globally into the US session. And then when European indices closed, e-minis fall off, and all the while you see the Euro/ruble cross rate trading pretty much in tandem with it.
I don't know specifically why that is, it might be short covering or whatever it may be, but the price action itself, you can tie that into Europe, so this is very much a European driven directional market at the moment.
ASH BENNINGTON: Yeah. Weston, those correlations are very elegantly explained and encapsulated in those charts. Obviously, as we said at the top of the show, clearly, fog of war type of situation, trying to figure out what's actually happening on the ground. But what we do here at Real Vision, obviously, unpack capital markets, understand what's happening. And those charts show us what we can see, which are these correlations. Weston, when you look at these, how do you know which direction the causal arrow is pointing? In other words, where the causality is flowing from and to?
WESTON NAKAMURA: I'm sorry, I don't understand. I'm not going to know where anything's going to go [?]? How do I make my best guess is what you're saying, or?
ASH BENNINGTON: How do you make your best guess, Weston, on the direction of these correlations, and how do you interpret them?
WESTON NAKAMURA: I cannot tell you, even in the near term, what the direction would be. But the way that I can look at that is that basically, if I can identify that, let's say the last two weeks of S&P downside and volatility has been due to the headlines coming out of Russia, and not at all due to any sort of FOMC rate hike or not adjustments and this and that. Then I believe that the Fed is just unchanged throughout this whole time.
Then come March 15th, or whatever the FOMC meeting is, if markets are still being priced strictly off of Russia-Ukraine headlines, and they have significantly deviated from where they should be relative to where the Fed is in terms of their policy, I can just position myself so that come the FOMC meeting, and the press conference and all that, and if markets could realign with the Fed, like, oh, yes, I forgot this thing, COVID, this whole thing exists, then you can benefit off of that divergence.
Those are ways that you can do it, but how the market goes from here, I can't look at that and tell you. I can't look at anything like that. But if there is some sort of discrepancy or unusual divergence in which markets are overly focused on one single factor, and there's another glaring factor like the FOMC, then those are ways that you can take advantage and close up that arb.
ASH BENNINGTON: Weston, one of the things I admire most about you is how data driven you are and the epistemic humility you so clearly display when you don't know the answer to a question. You're just looking at what's there. This is what the tape tells us. And this is what we're showing our viewers. Talking of which, the tale of the tape, what are you seeing in US energy markets and global energy markets?
WESTON NAKAMURA: Yeah, it's not just energy either. Just commodities in general, this is a chart I found that's basically-- I don't know how updated it is, but it's basically the number of commodities in simultaneous backwardation and it's at a record high. There's something like almost 20 commodities in backwardation, like simultaneously, which is pretty insane.
ASH BENNINGTON: Let's talk a little bit about backwardation and contango, these are the curves relative to the spot versus the future price of an asset in the futures market. This is an important point. Contango is when the spot price is lower, and the futures price is higher, so you see that rolling up. Backwardation is the opposite, spot being higher than the futures price.
WESTON NAKAMURA: Yeah, and so typically, with commodities, you're not in backwardation. The futures price would be higher than spot, but in this case, you're seeing spot prices that are above these forward prices because people are willing to pay a premium today for that underlying commodity. That is-- a spot price is not a financial instrument or anything like that. That's the price of like if you need heating oil today, you're going to pay whatever it is that the market is quoting, or corn or whatever it may be.
That's why what's so interesting about that is that there's so many commodities right now that are in simultaneous backwardation, there's just deficits across the board. And this is not something like financial alchemy or anything like that, this is real world demand reflecting that.
ASH BENNINGTON: Oil futures are physically delivered, which again, to your point about the real-world demand implications of these markets.
WESTON NAKAMURA: Right. With regards to, let's just take crude oil, for example. Brent was in the 99-handle today, almost hit 100, it's getting there. Now, you're getting all these sell side banks that are making these calls, I think Goldman has 105 target on WTI crude, and you have JP Morgan, whoever, saying like, if you get troops on the ground, then oil is 120.
If this happens, SPX is-- I don't know how these strategists can distill real world events into a specific price level for anything, not just for this stuff. And frankly, I think it's more or less nonsense, but what I can tell you is that I can tell you how the price of crude can get to and through 100 or even 120 this year on a mechanical level via options markets. That's something I can go over right now.
ASH BENNINGTON: Yeah, what's that scenario look like question, Weston?
WESTON NAKAMURA: Regardless of what's happening in Ukraine, in anything like that, purely based on the mechanics of how options markets, how they work. If you look at the crude oil options open interest table from CME, you'll see that there are a ton of call options opened that are out of money currently at the 100-strike level, there's like a wall of 100 strike calls on WTI crude of open interests that are open, particularly for the December 2022 expiries.
I have these strike prices that are these red boxes, if you look at that first one, that's the 100 strike. The columns are like the expiries. And if you look at the rightmost one, you'll see that 66,000 number, 66,000 contracts opened for December 100 strike calls on WTI crude. That's, what 60 million barrels worth of oil notional net one contract. That's like a half year of OPEC output in that alone.
There's an insane amount of 100 strike calls. There are also-- it's cut off here, but there are also call options being opened on not just 105, but on 110, on 120, on 125 that are being opened as well. Again, regardless of what the actual headlines are or whatever they may be, just mechanically, because of the fact that there's so much options open interest, you get that same dealer gamma hedging effect, in which dealers, the sell side banks that are taking the other side of the options positions, so they are short call options.
They have to buy, they have to always have what's called a delta neutral book. They have to have a directionally flat book, they can't take any directional position. They constantly have to hedge and so if they're short a call, they have downside exposure, they have to buy futures in order to remain delta neutral. And that buying of the futures in and of itself, that hedging activity pushes up that price and brings it into the money. You can see a scenario where crude just goes up to and through 100 and should it do that, it can easily get up to that 120 strike very quickly, just because of this gamma squeeze.
It's the same mechanics as GME from exactly a year ago or so. And this is a scenario that's very possible. That's why I can say, not based on headlines from this or that, but mechanically, these are specific levels that you need to watch. And you need to watch things like open interest and all that, and changes in open interest and positioning from the dealer side or the market maker side, and what their activity is like.
ASH BENNINGTON: Yeah, obviously, this is a case of where you have to watch the derivatives market to understand what's going on in spot and very well explained there. Weston, I wanted to take a look at a clip here on Real Vision today. This is Mike Green talking to Alex Gurevich about oil. It's very relevant to what you were just talking about. Let's take a look at that.
MIKE GREEN: In May of 2020, I put out a tweet as everyone was talking about oil price is negative. I'm like, guys, this is inflationary. Everyone's so focused on the deflationary aspect of oil crashing to negative $37, that means it only has one direction to go, it can only go up from here and that's going to play through directly.
And the dynamics of the market structure, particularly in things-- and again, this is just an experience base. If you had looked at the dynamics of the super contango that existed in May of 2020, spot oil is negative 37, one year out is somewhere in the mid-30s, or 40s. You're literally talking about an $80 swing in oil prices that was already built into the market at that point.
Now, if you look at the forward curves in oil, they don't reflect anything that looks remotely like that. Actually, what we see is the concern of shortages developing on a short-term basis, but on a longer-term basis, exactly to your point, the markets are just not that worried about it.
ASH BENNINGTON: Really interesting conversation with Mike Green talking about the super contango event, oil going negative. And the effective aspect of this being a rebound where inflation necessarily must come from the oil sector because of the fact that prices only had one direction to go. Weston, you and I were talking a little bit during the break about China, obviously, geopolitical stories, sometimes, like what's happening in Ukraine tended to crowd out other areas of the geopolitical spectrum. Tell us what is going on in China right now, and why do you think it's significant.
WESTON NAKAMURA: Well, the significance is the fact that it's China. But what I will say is, I think it was either the last time I was on with you, or when I did one of those RVDB updates. And I said that you're going to have a quiet period out of China during the Olympics because China wants to and will have a very headline quiet, smooth-running Olympics. But I also said that watch out for the closing ceremony of the Beijing 2022 Olympics, because that is going to be a catalyst for a release valve of geopolitical risk to just explode onto the markets and to society. And well, here we are.
ASH BENNINGTON: Shall we say, the closing ceremonies, you're talking about effectively not a statement at the closing ceremonies, but the fact that things are ending and therefore, a new regime shift in geopolitics?
WESTON NAKAMURA: Yeah. I mean that Vladimir Putin went to the Beijing Olympics opening ceremony and met with Xi Jinping in person just to discuss who knows what. Things were very quiet during that time period, because they both put their respective whatever on pause. I'm sure that Xi Jinping was like, look, do not mess up my Olympics by invading-- don't do your invasion in the middle of this. Wait till afterwards, or it was Putin saying, okay, I'll be patient and wait till afterwards to whatever.
But that's a time where everyone just played nice, put politics aside, let's just do some curling, and so on, and so forth. And now that that's over, you have all this pent-up stuff that's now coming to fore. This is not a coincidence of timing or anything like that, I actually had a position for this very specific catalyst. This is why I said that you have to look for what's not in headlines, just as important as what is. Currently, what is in headlines, obviously, is just this Ukraine-Russia story.
What is not in headlines, though, that is happening "under the radar", China is once again, cracking down on their tech sector. You saw the Hang Seng tape beating today the Hang Seng tech sector, especially names like Alibaba, Meituan. Meituan was like an Uber Eats, DoorDash company. They specifically said they didn't call out Meituan by name, but they said delivery companies need to lower the prices, and so they're getting hit by double digits, their stock is.
This is still ongoing in China. People who thought that they're easing up on the crackdown, they're