TCW Chief Global Strategist, Komal Sri-Kumar, says oils should be shorted because it is rising on hostilities and not on the deteriorating global growth. If hostilities are set aside, the dominating force behind the oil price is bearish. Current price, he says cannot be sustained over the next year.
Hedge funds have been fleeing the crude oil contract, the WTI, and with that the price of oil has dropped, data from the Commodity Futures Trading Commission (CFTC) shows.
Bullish-to-bearish bets by the hedgies have fallen to just 2.3-to-1 a far lower level than 11.8-to-1 from earlier in February.
As the chart above indicates, high bull-to-bear ratio is associated with skyrocketing prices so that when this ration approaches 2:1 we see prices go lower.
Based on the chart, however, each subsequent drop in the ration towards the 2 produced higher lows. As a result, some are arguing that there is technical price compression in WTI contract inside the blue triangle that could be potentially bullish down the road.
Anyway, the bulls in oil have been blunted by absence of war with Iran, crank-up in Saudi oil production to offset lost Iranian crude and new shale and tar sand reserves in US and Canada which are happy with a $100 price.
Recently, Goldman made a bearish call on oil by predicting “an end to the bullish oil price super-cycle”.
The rising tide of speculative cash that pours into the bullish oil bets in futures and options markets is fueling the oil’s price rise and a narrow market focus on the bullish-bearish net positions is an insufficient to see this patterns, notes Reuters market analyst John Kemp.
“Econometricians have struggled to find a statistical link between hedge fund positions and the rise in oil prices during 2008 because hedge funds were heavily represented on both sides of the market,” says Kemp.
Indeed, by looking at the net position chart (green line in the chart above) one can conclude that, in fact, the opposite may be true – that the oil spike of 2008 was accompanied by entrance of bear bets.
However, by plotting the absolute positions speculators held during the 2008, yellow space in graph below, the trend whereby speculative money pours into bullish contracts goes along the price spike in oil.
Similar is the case with the oil price from March 2009 to June 2011. During this period, there is a relentless rise in long speculative bets and as such bets accumulate the oil price gets inflated.
“Policymakers have wrongly interpreted this absence of evidence as evidence of absence, and concluded that speculation has no impact on the price of oil or other commodities,” notes Kemp.
“Even a simple review of the record suggests that conclusion is implausible. It reveals more about the flaws and limitations of the econometric techniques used than about how the market actually works.”
“Econometric techniques”… hm?
Much of the QE effect may already be “baked in” to the oil prices and smart money fading current rally says Robert Campbell whose column on QE, waivers, missing barrels muddy oil picture seems to have appeared only on the Reuters platform and not on their websites.
From the financial side of the ledger, the picture looks bullish, with accommodative monetary policy steering cash into hard assets.
Commentators have already suggested that the backwardation in Brent crude futures will likely steepen regardless of physical flows due to more financial buying being concentrated in the front-month of the curve.
But at the same time analysts are pointing out that much of the QE effect may already be “baked in” to crude prices.
No market trades the same set of conditions the same way twice. The market is a self-correcting mechanism. Arbitrage tends to erode what were once special opportunities as market phenomena become more generally appreciated.
So traders who missed out on any of the previous QE-induced commodity rallies undoubtedly sought to anticipate the latest boom. The real question is how much of their powder remains dry?
Indeed, the smart money may even be already trying to fade the current rally to catch the downward drift that has followed previous Fed-induced jumps in crude prices.
Campbell says that there are 200 million barrel unaccounted for and sanctions on IRan are routinely busted as “United States wants to turn a blind eye to some purchases
of Iranian oil by Asian nations.”
“Four minutes of hectic high volume activity that sheared $4 off the price of oil late Monday left traders, analysts and U.S. regulators looking for the cause of one of the fastest and most furious energy market routs in recent years,” a report describes the event.
CFTC is “looking into” the event.
“All of a sudden it just dropped, then it snapped right back up. Then you had 50-to-75-cent moves, so you saw guys just stay away from it. From there it was just a barrage of rumors. Everybody was asking the same thing: What the hell is going on here?” said John Woods president of JJ Woods & Associates, a brokerage on the floor of the New York Mercantile Exchange.
CFTC data as of last week shows that most speculators are holding bullish bets on crude as longs on oil outstrip shorts by 203,324 contracts for a net weekly increase of 9,700.
Oil price may be on the way higher as the ratio of bulls to bears at the Commodity Futures Trading Commission (CFTC) is swinging in favor of the bulls.
The spike in this ratio suggests that money is flowing heavily into bullish bets on oil while, at the same time, money is running away from bearish bets.
Such situation occurred twice before and we can see them in the graph above. The first one, from November to May of 2011 coincided with war in Libya, and second from October 2011 to March of 2012.
Typically, this ratio hovers around 2 to 3 but any spike towards 10 usually triggers “demand destruction” and is associated with an economic slowdown.
As a result, the end of both of these bull runs in oil price also coincides with a drastic fall in stocks.
In other words, sharp spikes in ratio of bulls to bears are followed with an economic slowdown and is expressed in a stock sell-off.
The net position of traders – the colorful graph above – also suggests that managed money and swap dealers are ruling the oil oil market with producers, consumers and merchants having no say so in oil’s price formation.
Speculators, aka money managers, have upped their bullish bets on oil and gasoline last week ending Friday August 10, CFTC data shows.
The spike in these two (RBOB is gasoline) is noticeably higher than from the flatline long holdings for much of the summer and some attribute the spike to a combination of falling supply outlook and talk of stimulus and war.
Citing weak cargo data for September North Sea Brent, traders piled on oil saying that the “export schedule sent to cargo owners. Daily supply will average 100,000 barrels per day (bpd), down from 271,000 bpd in August.”
There is also lots of talk of some sort of a coordinated central bank stimulus that is keeping oil’s bullish hope alive, although lots of immediate attention is going towards what Israel is signaling with respect to Iran.
“We are seeing prices rise despite weak growth outlook numbers on Friday. The Israeli comments, what you see in Israeli media, is a concern. A major concern,” says Ben Le Brun, a Sydney-based market analyst at OptionsXpress.
Reports are saying that there is a “frenzy of newspaper articles and television reports over the weekend in Israel suggesting that Mr. Netanyahu had all but made the decision to attack Iran unilaterally this fall.”
Israeli Deputy Foreign Minister is sayingthat the UN Security Council plus Germany should “declare today that the talks have failed” and when so then “it will be clear that all options are on the table” – meaning war.
Of course, none of this looks good for the consumer spending so some pressure in that space may result.
Finally, bearish bets on copper have increased yet again despite media claims that China has hit the bottom and that now stimulus will dominate the policy which, presumably, would be bullish for copper. China is seen as the sole driver of the copper price.
There is lots of confusion as to what is exactly going on in China with major bank houses cutting growth outlook as things develop there while others believe that stimulus is just around the corner. Suffice it to say is that the flow of money via copper shorts maybe more reliable indicator of China.
Data from the Commodity Futures Trading Commission (CFTC) shows that people who deal in physical oil have dwindled their short hedges down to virtually nothing and there is a lack of explanation as to why are they “abandoning” the futures.
The CFTC data as of last Thursday shows that the Producer/Merchant/Processor/User class of traders that participate in the futures (green line) have been cutting their short positions rapidly since March 2011 and if the trend continues may end up on the long side.
This class of a trader typically seeks to hedge downward price risk while transferring the risk of any future price appreciation to the speculator.
So why are physical users of oil not hedging the downward price risk? Does this mean that physical users of oil believe that oil has only one way to go – up?
Not clear but some CFTC changes in classification may have caused certain producers to be classified as speculators. If so, then the reclassification looks like an ongoing issue… or is it.
Speculators have reduced their bullish bets on oil since about mid March in a remarkably orderly fashion that has not triggered any major price sell off.
The long-short ratio has sunk from the peak of 11.8 to 1 to 5.4 to 1. The remarkable thing about this dramatic reduction in the size of bullish bets in oil is that it was done without a major sell off as it happened during a similar peak in 2011.
Huge bullish pile-ons like in 2011 are typically considered a crowded bet which if it does not materialize typically sends traders for exits.
Instead, speculators have trimmed their bullish bets but in their stead a new category of a speculator has emerged – Other Reporting.
Looking at the net positions of traders in oil, two other features emerge about the structure of the oil market as of April 10.
Category of Other Reporting (purple area) are money folks that are neither producers, merchants, processors nor users but they have accumulated sizable bullish bets.
Other Reporting category now claims 2.3 to 1 ratio of bullish bets which is about half as much as money manager’s positions of 5.4 to 1.
Also noteworthy is the shrinking size of the producers, consumers and merchants (green area). From March of last year until now, this category has reduced its hedges towards zero so that the oil futures are now almost exclusively dominated by money speculators – people who have no intention of making nor using oil.
Money people have established the largest long position on crude futures on record setting up for a hard fall in case that the tensions over Iran do not materialize.
As of last week, there are 11.8 long positions for every short one. Last year, in the wake of Libya war, this ratio spiked above 11, and a brutal sell-off ensued on May 5.
A more normal ration is around 3 to 1.
Speculators hold 332 million barrels of longs against just 164 million in October. Shorts are at 28 million.
The counterparty to these longs are said to be swap dealers and now hold the largest short position. So, if war with Iran happens, these dealers will have to buy some of these positions which could spike the price at a steep rate. Otherwise, the set-up looks very similar to last year with a possibility to be more brutal.
A good way to play this is via some ETF type like SCO (more here).
Money people are running up their bullish bets in oil and the spike resembles the one last year before the “flash crash” in oil when the price dropped $11 in one day.
According to the Commodity Futures Trading Commission trader commitment data as of February 14, 308 million barrels in long positions is held against 42 million short.
The long-short ratio (308/42) is at 7.3 meaning traders hold 7.3 bullish futures and options against 1 bearish bet.
From the graph we see that a more normal ratio is somewhere between 1.5 to 2.5 in that ratio.
Last year, war on Libya was the catalyst for a run-up. This time, good economic news from the US and talk of war with Iran is doing the same.
We may not be at the top in oil price but we certainly are closer to it.