Tag Archives: crude oil

Commercial Traders Ahead of the Game

The Commodity Futures Trading Commission publishes a weekly report entitled, “Commitment of Traders Report.” This report totals the positions by all major commodity market players and breaks them down into a few important categories. The category that is most predictive of future moves in the commodity markets is the Commercial Trader category. This group is made up of people who are hedging their need for the physical commodity to meet future production as well as the producers of physical commodities who are trying to get their future production sold at the best possible prices. These are the professionals whose livelihood depends on their ability to ascertain value in their particular markets. Following their behavior in the commodity markets is very similar to following the reportable insider trading in the stock market, in which employee transactions of large amounts of stock must be reported to the Securities Exchange Commission.

Following the commercial trader category provides keen insight into the commodity markets. Some examples are seasonals, divergences and macro economic expectations. Comparing year over year action against established seasonal trends can allow traders to catch a glimpse into the expected strength or weakness of the current cyclicality in a market. Crude oil typically experiences its greatest strength from early July through the end of August. This year, the commercial buying came in just as expected and the market made its most recent low on July 6th and has rallied from $71.50 to almost $83 dollars per barrel.

Divergences appear when a market makes a new multi month high or low that is not validated by the commercial traders’ actions. For example, today’s news that China’s property market is cooling off has already been reflected in the market by commercial traders who have sold this rally relentlessly and capped the rally for six straight trading sessions under $3.40 per pound.

Both of these examples tie into the macro economic expectations of commercial traders. The seasonal rally in crude oil has been cut short by heavy commercial selling over the last two weeks due to expected softness in global crude oil demand. Recent energy reports show that gasoline levels here in the U.S. are at a six-week high and our refineries are trending toward decreased capacity utilization. Furthermore, China, the world’s largest crude oil consumer, has decreased their imports 15% since June.

The capping of prices in the copper market by commercial traders is further evidence of an expected economic slowdown. Commercial traders who follow the markets that provide their livelihood are among the first to know and analyze important information. They were aware that China’s copper and iron ore shipments are down for the first time in four months and that their crude oil consumption is 15% lower for July.

Finally, we can extend this same analysis to commercial positions in other actively traded markets as well. The disappointing projections are for a weaker stock market, low bond yields and higher agricultural prices. The build up of short positions in the stock market over the last three weeks has been considerable. Clearly, professional traders’ expectations of the stock market are negative. This can be partially verified by the buildup of short maturity debt. Interest rate futures across the strip expect to see continued buying even in the face of added government stimulus and a weakening U.S. Dollar. In fact, one of the most fundamental traders of all time – Warren Buffet, has shown that they are increasingly buying short- term treasuries. This omen portends the possibility of profiting on a flight to quality as people pull money out of a falling stock market and place it in U.S. Treasuries for liquidity and protection.

Finally, professional traders in the grain markets have been making their stand in two ways. First, buyers of grains are supporting higher and higher floor prices. This means the folks at Nabisco, Quaker Oats and Frito Lay are all expecting the growing overseas middle class to put a squeeze on the United States’ ability to remain the, “bread basket to the world.” Sellers of grains, on the other hand, are more willing to let the markets spike higher and higher before capping their profit potential. This was witnessed over the last month as overseas growing issues forced U.S. grain prices up 28% in corn, over 50% in oats and the price of wheat nearly doubled.

Trading alongside of the commercial traders has been quoted as, “Following the elephants.” This provides three benefits. Their actions are reported weekly, making their path easy to find. They cut a wide enough swath through the market to allow us to slip in and out at our convenience. Finally, they offer a tremendous amount of protection. Trading the markets is hard enough on your own. Why not allow the elephants to guide you?

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures.

Crude Oil and the World Market

Crude Oil and the World Market


May has been an interesting month in the crude oil futures market. The crude oil market has sold off more than 25% of its value in the last month. It has gone from trading at over $90 per barrel down to $67 per barrel. The selloff has been based on two primary concerns; First, the continuing slowdown in Europe and secondly, the growing strength of the U.S. Dollar. However, commercial traders are betting that these concerns will be more than offset by continued growth in developing countries and declining domestic production through the politicizing of off shore drilling.

The European Union is going to face continued economic pressure as they deal with the after effects of their own credit bubble. We have written extensively about the troubles in Greece, “Pandora’s Grecian Riddle.” We also suggested that Greece would merely be the first European Union to succumb to the hubris of its own administration and that this would quickly be followed by Spain and Italy. An appropriate parallel is to the individual financial giants here in the U.S. as the government decided who lived and who died. For the purpose of understanding the selloff on crude oil, the important takeaway is one of simple human basic need. The countries in the European Union will experience a manufacturing slowdown. However, they will continue to cook, heat their homes, drive their cars and maintain the base needs of fully developed countries.

The growing strength of the U.S. Dollar has made crude oil cheaper because crude oil is traded on U.S. exchanges and priced in U.S. Dollars. Therefore, as the Dollar rallies, so does our purchasing power. However, since the beginning of May, the Dollar has only rallied about 7%. Obviously, this does not account for crude oil’s 25% decline. Of course, astute readers will recall that in February, when the Dollar rally began, crude oil experienced a 14% drop on a 4% rally in the Dollar. This created a selloff down to $70 per barrel before rallying back to $90. Therefore, the correlation remains within normal boundaries.

The growing case for crude oil bargain hunting at these levels can be made through the case of the developing middle class of very large Asian populations. The demographic argument states, broadly, that money follows population growth and education. Psychologically speaking, people first seek to meet their basic needs of food, shelter and clothing. As these needs are met and existence transitions to living, the population wants better food, nicer clothes, DVD players and cars. These populations will develop their economies from the inside. However, their production facilities will require more raw materials to produce an equal amount of goods than the efficient production facilities in developed countries. Their higher rate of consumption will help to support global demand for fossil fuels.

British Petroleum’s recent disaster in the Gulf will further constrict domestic supplies going forward. No one can argue the magnitude of this disaster. Many more Americans will truly see and feel the impact of this environmental calamity because it happened in the Gulf, rather than in Alaska, like the Exxon Valdez. The emotional impact will rally voters to back Obama’s moratorium on offshore drilling and put further National Park drilling in jeopardy.

Finally, let’s look at the market internals themselves. Commercial traders, via the Commitment of Traders Report have continued to buy the market the entire way down through this decline. This means that the people who live and die by this market feel that these are value prices. Their trading programs are not based on swing trading. Their trading methodologies are based on fundamental factors like supply and demand and currency exchange rates. They also incorporate seasonal usage data into their trading algorithms, which suggests the crude oil market should continue to see increased demand through the end of August.

The sum conclusion of this selloff in crude oil is that it should be viewed as a buying opportunity for the long term. This is one of the situations where efficient portfolio analysis would suggest that allocating a portion of an overall portfolio to inflation sensitive, fundamental goods would not only put your trading in line with the commercial hedgers, but also provide some overall portfolio diversification.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures.

Uncovering Value in the Commodity Markets

Uncovering Value in the Commodity Markets

The electronic meltdown in the stock market also cued a selloff in many commodity markets. Typically, markets move in their own individual rhythms. However, when fear dispossesses logic and panic takes over, it becomes a case of sell first and ask questions later. As the stock market selloff accelerated and we watched the media reports of the riots in Greece, survival became the primary concern. Now that the dust has settled, it’s time to appraise the current state of the markets. I believe the shock to the system uncovered some fruitful trading opportunities.

First, let’s examine the context of the markets prior to the selloff. In the currency markets, the Australian and Canadian Dollar as well as the Japanese Yen had been consolidating near the upper end of their ranges. All three had been holding their own since the U.S. Dollar’s rally has come, primarily, at the expense of the Euro, Swiss Franc and British Pound. The same pattern appears in the metals and energies as gold, silver and platinum as well as heating oil, unleaded and crude had also had been consolidating near their highs.

Secondly, let’s consider the composition of the markets’ participants through the Commitment of Traders Report at these price levels. Commercial trader positions in the markets above were gaining momentum in the direction of their established trends with the only exception being the silver market. This means that even as the markets were moving higher, the traders we follow, commercial hedgers, anticipated higher prices yet to come. For our purpose, we track the commercial hedgers. Prior to the market shock, we presumed that we were in a value driven futures market and no one knows fair value like the people who produce it or, have to use it. In fact, it is precisely their sense of value that provides the commodity market’s rhythmic meanderings that swing traders love so much. Let’s face it, producers know when their product is overvalued and it should be sold just as well as end line users know when they should be stocking up at low prices.

Finally, in the wake of “Volatility’s Perfect Storm,” we have seen the commodity markets snap back from losses of 3% – 4% in the world currency markets to 7% – 10% in the physical commodity markets. This sharp selloff and snap back to the previous range of consolidation prices is called a “Spike and Ledge” formation in technical analysis and pattern recognition. Typically, this occurs when an outside force creates a counter trend shock to the market and scares everyone out. The fear of being in the market is replaced immediately by the fear of NOT being in the market and missing the move. The shock forces out the market’s weaker players while allowing the strong to accumulate more positions at better prices. This is why COT Signals has been kicking out buy signals since the meltdown. Following the commercial trader positions has allowed us to buy into oversold markets. Our targets for these positions can be calculated by adding the depth of the market’s decline to the top of the consolidation levels. If the market you’re following sold off 5% from its highs, a spike and ledge projected target is 5% above the market’s previous highs and a protective stop would be placed just beyond the spike.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures.


Who’s Right?


This blog is published by AndyWaldock. Andy Waldock is a trader, analyst, broker and asset manager.Therefore, Andy Waldock may have positions for himself, his family, or, hisclients in any market discussed. The blog is meant for educational purposes andto develop a dialogue among those with an interest in the commodity markets.The commodity markets employ a high degree of leverage and may not be suitablefor all investors. There is substantial risk in investing in futures.

This morning, (11/9/09) the U.S. Dollar is significantly lower and testing the ’08 lows. Gold is making new highs and holding over $1000 per ounce and crude is up $1.60. This is as it should be in a Dollar devaluing world, global assets priced in Dollars should climb in response to its decline. Economics 101 tells us that there is a negative correlation between global asset price and the price of the Dollar.

So far so good, right? Not so much. Every weekend, I download the Commitment of Traders Reports to see what the different categories of traders are doing. The three main categories  I track are the commercial traders, the small speculators and the funds. As many of you know, a big portion of my trading is based on the momentum of the commercial traders actions. There are three main reasons for this. First, they understand the fundamentals of the markets they trade – their markets are their business. Second, as the fundamental players in the business of their markets, they have a vested bottom line interest in pricing their products profitably. Finally, when they act collectively, based on their fundamental knowledge of their markets, they have the resources to move markets. Therefore, when they move, I want to be on their side.

Typically, the commercial positions rise and fall with the ebb and flow of the markets. They may act within the channel boundaries of a trending market or, they may be trading against support and resistance in sideways markets but, typically, they use their fundamental knowledge to pick the right side for the coming period of time.

Occasionally, we see these relationships pushed to the extreme and this is one of those times. I’ve selected three markets to illustrate this point – Gold, Crude Oil and the U.S. Dollar. As the Dollar has declined over this past year, we’ve witnessed a steady building of commercial long positions with a net accumulation of approximately 20, 000 contracts. Crude oil has seen commercial net short positions increase by more than 100,000 contracts since July. This also places Crude at a new net short record, eclipsing the August of 2007 mark. Finally, we have the Gold market. It’s been in the news everyday. Beginning in September, we can see that once the market started to breakout above the $990 level, commercial traders began to increase the pace of their selling. They have increased their net short positions by more than 30%. The final point to make is that people on the other sides of these trades are just that, people. Remember that it takes both a buyer and a seller to create a trade. The commercial entities need someone to take the other side of their trades. Those someones are the small speculators and the commodity funds. The commodity funds will always maintain a certain percentage of their assets in a given market. They adjust their asset base according to price, adding to their positions as prices rise and paring back their positions as the markets fall. Most importantly, they position themselves from the LONG SIDE ONLY. The small speculators can and do, trade both sides of the market and they are typically long at the top and short at the bottom. So, if the commercials have accumulated large, in some cases historical, positions that are opposite the markets’ current direction, who do you think is on the other side of their trades with historically sized positions betting on the trend to continue?

These are interesting times with the elastic band of the markets stretched to historical proportions. As a trader, I’m never one to bet my money against a trend’s continuation as my bottom line is only effected by the last traded price. Markets can remain irrational far longer than I can hold a bet against them. However, it would behoove those participants on the side of the small speculators to tighten up their protective stops as a reversal of fortune could send a record number of players heading for the exits.


Growing Rift in OPEC

Wednesday’s OPEC meeting was quite noteworthy. The headline news stories tell us that OPEC agreed to cut crude oil production by 520,000 barrels a day. The headlines won’t tell you that the ties that bind OPEC are unraveling at a wonderful rate for crude consumers. The addition of Hugo Chavez and Argentina’s emergence on the global oil market, combined with Russia’s re-emergence as one of Europe’s primary suppliers have created a rift within OPEC that seems to be widening. The political aspirations of the membership as well as their allegiances with non-OPEC nations are forcing the once cloistered group into open public confrontation.

Note the following excerpts from the Associated Press’ coverage of the meeting.….Behind the scenes, the 13-nation energy cartel juggled the conflicting interests of Saudi Arabia and Iran – and brought oil and gas giant Russia closer into the fold by agreeing to sign a cooperation agreement with the Kremlin.

However,…… “Russia does not want to be in OPEC because it means adhering to quotas which is not what Russia wants,” she (Cornelia Meyer) said. “Russia does not want to comply with anyone’s wishes but the Kremlin’s.”

Furthermore,…. Saudi Arabia’s clout is key for Washington. President Bush visited Riyadh twice this year to push an oil production increase. The Saudis answered by ramping up production by about 500,000 barrels a day.

If we combine the above statements, with the following statements, from Douglas A. McIntyre from 24/7 Wall St. we can see that the primary information to take from these meetings is the impossibility of coexistence between a fractious OPEC combined with the differing agendas of new powers on the block, Argentina and Russia.

…Saudi Arabia walked out on OPEC yesterday. It said it would not honor the cartel’s production cut. It was tired of rants from Hugo Chavez of Venezuela and the well-dressed oil minister from Iran.
As the world’s largest crude exporter, the kingdom in the desert took its ball and went home.
As the Saudis left the building the message was shockingly clear. According to the New York Times, “Saudi Arabia will meet the market’s demand,” a senior OPEC delegate said. “We will see what the market requires and we will not leave a customer without oil.”

Basically, ….”OPEC needs that for the Saudis to have any credibility in terms of pricing, supply, and the ongoing success of its bully pulpit. By failing to keep its most critical member it forfeits its leverage.”

Bill Siedman, market analyst and respected voice on CNBC, sees this dissent as a good thing. To paraphrase his comments, “There is no question that dissention within the oil cartel will lead to better price discovery of the true value of a barrel of oil. The Saudis are leading the dissent. They are the largest contributing member and have the largest oil reserves. They also possess the infrastructure to put these reserves on the market rapidly. They are, essentially, the leaders within the cartel. When push comes to shove, it’s their ball to call.The important thing to note from these meetings is that since 9/11 and Katrina, the U.S. and the world at large have been pushing alternative fuel technology. Even though our energy plan lacks coherence, the combination of the auto industry’s push towards fuel efficiency, the private sector’s growth of alternative power generation and academia’s funding surge channeled towards alternative energies are all effectively undermining the future power of petroleum.

The primary members of OPEC see the writing on the wall. They are using their petroleum revenues to diversify the economies of their countries. They are investing in infrastructure and technology at an unprecedented rate. Even though these processes take many years to develop, I believe we will be able to look back on this meeting, in the wake of $145 oil and say, “That was when it all started to unravel.”


Dollar’s Strength an Anomaly?

The U.S. Dollar surged through its daily resistance and is well on its way into the overhead weekly resistance between 75.88 and 77.24. Although the rally has been impressive, it’s important to maintain the perspective that the Dollar is in a bear market. Even if we were able to rally another 300 points, that would only bring us back to the 38% retracement level from the ’06 highs.

Of recent interest in the Dollar’s surge are the factors that television commentators claim are fueling it. The major factors receiving notice are, the decline in energy prices and commodities in general, the European Central Bank’s deflationary comments and finally, the worse than expected jobless claims number. The following factors are deflationary and the U.S. equity markets are rejoicing.

I would ask the question, “Have the preceding factors created a bottom in the economic cycle or, are we seeing a more general global slowdown?” I believe that the domestic economic issues have not been addressed and that a globally deflationary environment will create more problems for the U.S. Dollar than it will solve.

First, examine the chart on import prices. The double top may have proven to be the limit. Clearly, it has already begun to turn down. This index includes oil which, when priced separately, is 5% higher than imports in general. Oil is germaine to the topic because the $25+ decline has NOT been priced in and will contribute greatly to the establishment of this chart’s double top.

If, in fact, overall commodity prices are topping out then, this will also reduce demand for U.S. commodity exports. Exports have helped to offset the declining Dollar over the last two years as global demand and globally anomalous weather patterns have made the U.S. the supply center for the world. Dollar strength and, or a global slowdown will curb the primary growth engine for the U.S. economy. What effect will this have on a sluggish employment picture?

Obviously, the unemployment pressure is still to the upside. Will global commodity deflation offset the cost of a declining employment base? According to many pundits, the tax refund checks have gone to cover current expenses, rather than paying down debt. That leaves many people still looking for meaningful employment opportunities. This is most clearly illustrated in this week’s jobless claims.

The past two weeks’ claims have surpassed the historically significant 450,000 threshold. As you can see from the chart, this threshold is frequently accompanied by a recession. Based on the previous factors, I fail to see continued strength in the U.S. Dollar or, the U.S. economy. While the equity markets have broached the 20% bear market threshold and, recently bounced, I still view this as a selling opportunity in both equities and the Dollar.

It appears that this is beginning to be priced into the interest rate markets as well. Inflationary pressures are easing. This is taking the pressure off of the Federal Reserve Board to tighten rates at the next meeting on September 6th. Furthermore, the declining employment picture will add pressure to hold or, LOWER, rates at meetings through the end of the year. This stance is contrary to the hawkish inflationary stance that has been their premise for much of this year. Finally, the combination of a declining equity market in an election year would also add to the shift in the FOMC’s position from hawkish to dovish. The last chart is beginning to tip the market’s hand as it points to lower rates ahead……once again leading to a lower Dollar.


A Quick Memory Test

Q:Last week, crude oil fell $20 per barrel. According to the Department of Energy’s “First Purchase Price,” when was the last time crude traded at $20 per barrel??????

A:March of 2002! I certainly thought it was pre-911.

Click on the link for the full DOE price series.

8-3 doe.asp.xls



Counter Trend Moves…What’s Next?

This week’s commodity trading featured many strong counter trend moves. Many of the markets saw swift turnarounds in trends that have been established for weeks and months. The 64 million dollar question is; “What’s Next?”Here is what I’ve defined as established trend and counter trend moves.The following markets are share the following traits:

1) They are all near their respective 13 week highs or, lows. The market began within spitting distance of its  recent extreme.

2) Their weekly sentiment readings are > 70 or < 30, respectively. Each market has a large, one sided public following.

3) They’ve experienced a large 5 day counter trend move. All week the market has moved conter to the public’s expectations.

4) Thursday’s ranges were larger than average. The market has moved far enough to force traders into action.

These criterea do a reasonable job of establishing a market direction and bias. Now, what can we learn from this. Is the counter trend move done? Does the longer term trend hold? Are the market’s topping or, bottoming out? Based on the following statistice, we can see that not all of the markets react in the same way.

Here is what to look for in a general sampling for the coming week. We can expect, in order of predicted strength, the following markets to bounce from the week’s declines.PlatinumNatural GasCrude OilSoybeans

Sugar looks like it will continue to decline, reaching a projected low of 1111 approximately 7-8 weeks from now.

The S&P 500 shows the strongest statistical bias. According this week’s events, we can expect the S&P to continue its rally over the coming month, peaking around 1312.

Rare Occurrence in Crude

The fundamentals in crude oil have continued to erode since February of this year. The highs, over the last $40, can be viewed as a “bubble.” This bubble has been fueled neither by Commodity Index Traders and large speculators, nor Hedge funds and carry trades. I think a strong case can be made that the last leg of this rally should be attributed to large producers unwinding their forward hedges. Producers and forward short hedgers are subject to human error just as individual traders are. Hedge transactions manifest themselves in the Commitment of Traders data as commercial purchases when the market makes new lows and as commercial sales when the market rallies. Just as most economic decisions are made, “at the margin,” so too are the hedger’s trading decisions. Their traders use their understanding of the fundamentals in their market to create oversold and overbought zones within the market’s natural movement and attempt to trade accordingly.

This strategy works for them the vast majority of the time.  However, when a market unhinges from fundamental factors and begins trading on sentiment, the commercials find themselves at the mercy of the public at large. Using the chart below, the white line represents the commercial index of positions on a scale of 0 to 100. Zero equals totally short and can be seen at the following points, (5/06, 7/07, 8/07). One hundred equals totally long and can be seen at, 6/05 and 10/05. Currently, the index is at 78, the highest since a 79 reading in February of ’07.

The yellow line represents total open interest. Technically, speaking, in a healthy trend, open interest should increase as the market moves out to new territory, either higher or, lower. This has not been the case with crude oil. Open interest peaked in July of ’07 and has continued to decline ever since. Open interest now stands at 1.3 million contracts, the lowest since March of ’07.

Furthermore, I have discussed, at length, the negative spread we’ve seen between the front month prices and the later expirations. In real terms, this backwardation in prices is evidence that producers don’t believe that we will be near these prices as the deferred contracts come due for delivery. Producers continued to sell the deferred contracts in order to lock in profits at levels they don’t believe will hold into the future.

Lastly, over the last previous weeks, we have seen the total commercial position shift from net short, to net long, with the market at all time highs. Therefore, I would suggest that the rally from the January highs, under $100 per barrel through the current highs, over $145 has been driven by commercial capitulation and a speculative blow off, rather than fundamental supply and demand issues. Ultimately, it proves the old adage true for everyone, even the big guys, “The market can remain irrational longer than one can remain solvent.”

Historically, there have only been three times when commercial positions have shifted from net short, to net long while the market was at all time highs.  The market declined, twice, by an average of 22.5% and once, the market rallied by 5.8%. Clearly, we are on the cusp of a top. Given the magnitude of a possible decline, one may be advised to purchase put options. Those wishing to sell futures may wish to wait for a close under $140 to initiate a short position.

Crude Fundamentals Remain Negative

The underpinnings of the Crude Oil market do not justify the current market prices.

1) Crude made new all time highs Friday….on declining open interest, which peaked last July.2) Distant delivery for Crude isn’t charging the storage and insurance premiums it should in a healthy bull market.3) Using NYSE prices, oil stocks are pricing it at $75 per barrel. 4) According to Business Week, the major players have done little to increase capital spending….even at these prices.