In going over some of the various COT reports and having a look-see to observe who is doing what, I wanted to make a few comments about the crude oil market, especially in light of one of our astute posters here who pointed out the very large imbalance currently existing in that market ( thanks Jesse L.!).
Take a gander at the following COT chart and you will see exactly what he was referring to. This chart goes back Eight Years - to the time that the CFTC began breaking out the Disaggregated Report.
If you notice, all three categories of speculators, the Hedge Funds, the Large Reportables and the Small Specs or General Public, are on the same side of the crude oil market, namely the long side.
There is nothing wrong with that since the trend has been a steady grind upwards, which until recently was stalled near the $105 level.
However, the sheer size of the hedge fund positioning is what is so striking. It is enormous and is at the largest level that has been seen, far eclipsing that which existed when crude was near $150 back in the summer of 2008 ( just before the credit crisis erupted) and when crude was responding to rounds 1 and 2 of QE in April 2011.
Another interesting thing to note - while the big commercial category is not at a record net short length, they are not far from one. The difference in the short positioning in this market at the current time, compared to when the commercials held their record net short position during August 2013, is that back then, the SWAP DEALERS were actually on the net long side of the market as well. Now those Swap Dealers are net short as well. As a matter of fact, the only category of traders that was net short the crude oil market back then, was those commercials - everyone else, including the swap dealers, was net long.
Crude Oil was just shy of $112/barrel at that time. It then promptly proceeded to collapse some $20 barrel in the matter of three month's time all the way to $92. It has since refused to go back down below that level and is now knocking on the door of $108, a mere $4 off the peak made last August.
How all of this plays out in the coming weeks is going to be very interesting to say the least. I think it important to reiterate that spec positioning in a market can go to extreme lengths and continue to increase long after many believe that a reversal is imminent. After all, who is to say just how many speculators can crowd into a market before it gets too lopsided? Answer - no one.
I well remember taking some of the usual pundits in the gold community to task publicly back when gold was running in a strong bull market some years ago. These self-anointed COT expects were consistently regaling us with "gold is going to have a sharp selloff" nearly every week when the COT data came out merely because they somehow arrived at the conclusion that there were "too many specs" on the long side of the market.
My rebuttal to that simplistic and inept analysis at the time was "who appointed these people to determine how many speculators can come into a market and where did they obtain this special key of knowledge that no one else seemed to have"?
Here was the simple truth back then which remains the simple truth at the present - We simply have no way of knowing how far their buying can drive prices and to what levels they can take it. As long as they are willing to commit money into a market, it is going to move higher. When you consider the amount of money that has been created by the Fed since the inception of its QE programs, and the ZIRP of the Fed, there is a huge amount of HOT MONEY out there that can invade any market and catapult it higher once the commitment is made to invest in that particular market.
Just look at the stock market for Pete's sake if you have any doubts about what speculative buying can do!
So what are we to think about this crude oil situation as traders? Answer - first -what is the direction of the market? Answer - it is trending higher with a series of higher lows since June 2012. The move up has been stymied at times at key resistance levels ( which we noted was one such occurrence at the $112 level) but the market has steadily ground higher. The $105 level had recently served to cap its upward progress for the last three months but that finally gave way when the situation in Iraq hit the radar screens of traders.
What this tells us is that sentiment towards crude oil remains strongly bullish and the trend is currently higher. Don't try to be a hero therefore and fight the tape just because the positioning of the specs vs the commercials is so lopsided in this market. Guess what? It can become even more so!
Secondly - do watch however and be alert for any signs of market reversals. When you have this many speculators crowded on any one side of the market, it does make for an inherently unstable market, one in which longs can become very jumpy and nervous for fear of sharp moves lower. This can and often is reflected in big spikes followed by sharp selloffs followed by big spikes up again. In other words, rising volatility can indicate increasing nervousness.
I have remarked about this in the past but want to do so again - markets, especially the "futures" markets ( not the "past" markets or even the "present" markets) tend to look ahead and price in the worst ( or the best ) news and price that in accordingly. We traders refer to the event or scenario as the price "having baked into the cake" the news.
In the case of crude, it has already baked into the cake quite a bit of bad news. With ISIS moving down through Iraq and threatening to seize key oil producing regions, the crude oil markets were rightfully concerned. Then we had the Ukraine situation which seems to flare up, recede and is currently flaring again. Once again, crude oil, which is always sensitive to geopolitical events, has priced in some risk premium.
So here is the big question that I am currently grappling with as a trader - just how much higher can these geopolitical concerns take this market at this point? I ask myself that question because of my current view of the US economy - let's face it, given the very tenuous nature of growth taking place at the moment, can this economy cope with sharply higher energy costs without seeing the "energy tax" impact begin to curtail growth? in other words, at what point do energy prices begin to significantly negatively impact growth?
We are all well aware of the high cost of meat right now for consumers. Until recently, gasoline prices, had been a bit more well behaved even if they had somewhat risen. Now they are threatening to move strongly higher also. You then get the ONE-TWO sucker punch to the struggling consumer which has to negatively impact economic growth as disposable income goes more and more to the basic needs.
At some point, demand for energy will then be affected, just like it always is during times of very high prices. When that point comes, and none of us know in advance when it will take place, crude oil is going to experience a significant round of long liquidation as longs begin to book profits and head to out of the market.
I would also be watchful for signs of the various Fed governors heading to the microphones and begin to try talking down some of the commodity sectors if things get too heated. I think Janet Yellen has a steep learning curve when it comes to grasping the significance of her own words and perhaps does not yet understand that she needs to be very, very careful about what she says.
I can still recall Ben Bernanke sounding a hawkish note on the Tapering thing last year and the havoc that produced! It did not take him, or the various Fed governors very long to hit the talk circuit sounding a much more dovish note after they observed the reaction of the various markets.
let me close this by noting that I am sincerely grateful for all of you who took the time out of your schedules to write and post here in response to my solicitation about making a few changes to the site. I cannot honestly make the time to thank each and every one of you personally by responding to your posts but I do want you to know how appreciative I am for both the kind words and very good counsel. Some of you should be webmasters because it is obvious that you are far, far more knowledgeable about internet publishing and websites than I am!
As some of you know, I have wondered at times whether the harsh emails that too often have filled my private email box were worth putting up with in order to keep writing. Sometimes I forget that there are far more very kind, and very gracious people out there and that they, more often than not, usually are quiet and reserved. hearing from some of you as well as some of the regulars here, has been a great source of encouragement to me so I thank you for that!
"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat
Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput
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Saturday, June 21, 2014
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