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”.
Speculators have cut their bullish bets on a several key commodities as the dollar surged higher on Friday.
Speculators have cut down on their bullish bets in oil by 8,779 contracts and increased their short positions by 6,698 contracts for a net bearish looking position of 15,477 contracts.
Bullish bets on gold were also slashed by 9,992 contracts but betting short was much smaller to 2,142 contracts indicating that some still hope gold will turn bullish again.
Bullish bets on copper – a key industrial indicator with a huge correlation with stocks – were also slashed. Bullish bets were slashed by 4,182 contracts and short bets rose by 6,921 contracts.
Bearish action in copper maybe related to 3 different things: rise in the dollar, less-than stellar expectations for Chinese rebound and too much (and uncertainly high) copper inventory in Shanghai bonded warehouses.
“Stocks held in bonded warehouses in China may be almost three times larger than those monitored by the London Metal Exchange, according to an estimate this week from researcher Wood Mackenzie,” reported Bloomberg last week.
The concern is that slow to recover China’s economy may fail to absorb these huge copper inventories, forcing the owners to re-export the metal back to the global markets – and that could tank the price.
“Given how low copper prices are now, it would make sense for smelters to put excess supplies under financing until the markets recover. To do that, they’ll have to put them in warehouses and get receipts,” CIFCO Futures analyst Zhou Jie said.
Gold’s negative reaction to the rise in the dollar, despite an ongoing QE, is another piece of evidence that casts doubt that being bullish on gold should be predicated solely on the amount of new currency printed by the Fed. This, however, maybe short term effect.
“In the short term gold may hover around Friday’s low, but there isn’t much room on the downside as easing monetary policy is still a global trend,” said Li Ning, an analyst at Shanghai CIFCO Futures.
Others think the bullish dollar effect predicated on strenghthening of the economy will prevail.
“But the dollar looks likely to maintain its uptrend. The dollar charts look bullish and better economic fundamentals in the U.S. compared to Japan’s also favour the dollar,” says Teppei Ino, currency analyst at the Bank of Tokyo-Mitsubishi UFJ.
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.
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.
Speculators increased their long positions in Brent crude by 4.6% in the week ending February 7, ICE data says.
Net long positions rose to 90,395 contracts against 86,423 previous week. Rise in net long means that there are are more speculators betting on a higher price in Brent.
Total bets, or open interest rose by 72,423 contracts.
“[Nymex crude speculators] marginally expanded their net long positions in WTI, which corresponds to a largely stable WTI price in the week under review,” Commerzbank said in a note.