Tuesday, November 8, 2016

Oil Not Right Yet - Still Leaning Bearish

Since October 19th, we have maintained a bearish view on WTI.  Crude Oil traded from a high of 52.22 (December 2016 future) to a low of 43.57 on Friday (November 4th).  Though there had been 11 new session lows in as few as 12 sessions, we remain somewhat confident that, while stretched, a low price has not yet been achieved on this move. 

A new daily high was reached both yesterday and today (Tuesday, November 8th).  This advance has led to the break of a very sharply sloped downward channel which had captured trade over the 6 consecutive session new lows ending Friday.  Clearly this should be viewed as a sign of a shift in momentum.  However, we do not see this as a terminal change in momentum and as such it is not enough to move us from a bearish view.  

Today I will review changes in futures open interest for market participants in general as well as changes in ‘large spec’ and ‘small trader’ (CFTC described ‘non-reporting’) positioning in the CFTC - Commitment of Trader Report.  We believe this information argues for still lower price action to follow. 

First, as noted previously, Crude Oil aggregate open interest has continued to rise.  Since the December contract peaked on Oct 19th, open interest increased by 145,000 as the contract fell in price by 17% (8.65) to Friday’s low.  Increasing open interest shows that collectively, longs who have been taking a beating, have not removed their positions.  Sure, there has been some change in ownership, but even substitute longs have not fared any better fate over the last 3 weeks.  Here is a look at the open interest change in WTI futures positions:  


Note that even on Friday in an 11th new low, open interest increased by 19,000 and on Monday, open interest rose by another 26,000.  We are interested in learning who is taking up these positions.  Earlier (Bear Oil Trend Still Strong) we looked at the participation by CFTC described ‘non-commercial’ accounts, often referred to as ‘large spec’.  These account types had been piling into long positions since the September 20th reporting date.  Their net long positions (futures and options) rose by 180,000 contracts through the October 11th reporting date 3 weeks later.  On Friday, it was reported their net long position had dropped by 44,000 or roughly 10% in the week ending November 1st.  The drop in ‘large spec’ net longs (futures and options) tells us that hedge funds have been coming out of their long position. 



To summarize, hedge funds have been removing bullish oil trades (CFTC report) at the same time that overall participation has been increasing (CME reported Open Interest increase) and prices have been generally falling.  Someone must have been taking up the bullish positions removed by the hedge funds, but who? 


The CFTC records the level of participation of the ‘small traders’ by netting out both the ‘commercial’ and ‘non-commercial’ account types, calling them ‘non-reportable’.  In this case, as shown below, we can see that the small trader has been adding to net long positions over the last month.  So to some extent, it appears that positions have flowed modestly from hedge funds to small traders. 




We recognize the capacity of the small trader to hold loosing positions as somewhat limited.  As they have been collecting new long positions into a bearish trending market, they will need to find some relief soon if they are to be expected to continue holding their long positions.  This recovery from Friday’s low may be just the encouragement they need to hold on a bit longer.  However, if we look to the timing of their position entry as marked by the graph above (complements of the CME), we see that they are terribly underwater still.  The position accumulation of 26,000 net longs began at a December futures equivalent of no less than 49.10 and appears to have increased steadily as the contract reached to the Oct 19th high (52.22) and then back to a low last Tuesday of 46.20.

As noted earlier, prices have firmed again today.  As I write, CLZ6 (December 2016 Crude Oil) trades at 45.25, 0.36 higher on the day, but about a dollar below the lowest possible price in accumulation in the week ending last Tuesday (latest report).    



Positions have grown by 45,000 in the last two sessions (Fri/Mon) and these longs are betting on oversold conditions bringing new buying interest.  As it is however, small traders are already long and holding a losing position.  Hedge funds too are very long and have decided that they no longer want to hold their position.  The small trader and to some extent commercial hedgers (airlines and the like) have been taking the other side of hedge fund selling. 


At some point, I believe that the interest by hedge funds to remove their long positions will outweigh the bullish interest of small traders to enter into new long positions.  Commercial hedgers are somewhat indifferent and would likely want to wait until the outcome of this situation is resolved before buying into weaker price action. 

We are not blind to the potential for momentum shift even as we renew our recommendation for bearish positioning.  Today is a second session where a new low has not been reached.  For the trend of consistent session lows to be maintained, a new low below 43.57 would be needed before tomorrow’s close.  Without this new low, an arrow in our quiver of conviction will have been spent.




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