The heating oil market has developed a textbook pattern for trend following continuation lower. This week, we’ll look at how these long-term, macro-economic trends play out through the eyes of the commercial traders in the Commodity Futures Trading Commission’s weekly Commitment of Traders report. We’re going to examine the cycles of accumulation and distribution among the market’s participants as well as where we are in the current cycle. Finally, we’ll end with a shorter time frame chart that details the actual commitment of trader’s buy and sell signals over the past year in the heating oil futures as we begin to develop our energy outlook for 2016.
I was fortunate enough to be interviewed for a Wall Street Journal heating oil story last week. The primary question was, “How high can prices soar?” Supplies have tightened up considerably during Mother Nature’s onslaught and another bout of cold weather is hitting us, pushing prices higher yet again. Short-term demand related issues like the ones we’re experiencing now due to the weather are never a reason to jump into a market. My less than sensational outlook on current prices pushed me to the closing section of the article. This week, I’ll expand on the topic by looking at the diesel and heating oil markets and formulating a trading plan for the current setup.
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.