The market is flat, flat, flat, flat... if you need charts, go to yesterday's post ;) they're mostly going to be the same. So now it's time to learn something. Hah hah.. sucks to be you.
Have you ever heard of the Commitment of Traders? I'm in a hurry so I'll let WIkipedia summarize it for you.. It's released every Friday @ 3:30 and reflects the trader obligations from the previous Tuesday in things like commodities and futures. It tells you who holds what, who's short, and who's long, and it paints a picture of the overall dispersing of risk between different types of people who trade this stuff.
So for an example let's talk crude oil. The latest report is here go to the bottom--click oil. It's hard to link the chart directly because of Reddit's formatting...sorry :)
. What you can see here is who is long and who is short crude oil contracts relative to the contract specified. Here we are looking at the current front month (I'll have a lesson in crude contracts and contango another day explaining what 'front month' is). So let's just say the April 2016 contract for now.
The chart is always s window into the action behind why crude is doing what crude is doing. The first takeaway are the categories at the bottom.You have Managed Money who speculate on futures (think hedge funds), Producers (people who do stuff with oil--drill it, ship it, make gasoline from it) , Swap Dealers (more on this later), and other... you and me, and a bunch of other things fall under "other"
The top chart lumps these categories into commercial (people who play with the black stuff), non commercial (funds and speculators), and small speculators (again you and me...)
The first thing to notice is that hedge funds in general are almost always net long in oil no matter what prices are doing going all the way back to April of last year. As are you and me, the little guys... But it's the producers that are always net-short. As in everyone: Iran, Saudi Arabia, Shell, Exxon, Mom and Pop Oil Shipping Inc... SHORT oil. But wait... why would you be short the oil you are trying to sell, buy, use, etc? Doesn't go against your best interest and your business?
First and foremost to be "short" a contract means that you are expected to deliver said commodity upon expiration, so there's a huge chunk of that "commercial" short--the people delivering barrels of physical oil. But what about those expecting delivery of the oil, like Shell? The people turning it into gasoline. Why would they want to be short oil? Let's dive into swaps and that "swap dealer" category. The swap dealer is a fancy name for the counterparty to the swap trade. I.e. think the "market maker" for the swap market. A swap is simply a contract between two parties for arranged cash flow, and that's it.
So how does this tie into oil? Well say that you are Shell and your entire business model for the year revolves around having a locked in maximum price you would ever pay for oil, that way no matter what happens in the market (up or down) you pay a fixed price for oil (GREAT for business planning, btw!). Well in the swap arrangement you can lock in that price, so if the price goes up you are reimbursed for the difference so you are locked into the net "same price."
It's hedging against the market changes, and that's it.
On the other side of the coin, say you are someone who pumps oil out of the ground and you want to sell oil at a fixed price, regardless of if the market is going up or down, that way you can make sure you get a constant profit. You do the same thing on the other side of a swap. If the price goes up, you pay out the difference to the institution on the other side of the swap (who profit off of this), but if the price goes down you still can sell at the arranged price.
So this wiggles its way into producers (drillers, exporters, refiners, etc) having net short positions because of hedging... and somewhere in the middle the "swap dealers" end up having a wide range of either net long or net short position in oil.
How to digest all of this
The way I always understood it was to look at it like a stock. As the middle men in the trade (market maker), they are capitalizing on the spread between the long and the short. So if those needing physical oil don't demand as much, but the market is flooded (like it is now) then you will have the swap dealers holding the risk in oil. So as oil prices fall because of oversupply (a huge net short from the producers) swap dealers start to go net long to capitalize on the spread of the falling oil prices against the (lets use the example of driller ABC who wants to sell oil at a fixed price). The swap dealer now has spread advantage of holding a $20 oil contract but company ABC is selling at $30. Now you see where profits come from in the swap world...
Often (like last year) you will see swap dealers be net short almost the same as the producers when oil is trading very high (companies participating in swaps and hedging in case of falling oil prices), but around August of last year swap dealers took on more and more oil risk, and around January of this year crossed over into net positive. This was one of my indicators for oil starting to bottom out and turn around when the summer demand started to pick up. Higher demand for the rummer of course you will want to be long oil, especially in a glut environment--oil is dirt cheap, sell it for more later, bam--profit. And as you can see as the oil reversal clearly took place about 3 weeks ago the swap dealer curve started to flatten out and is now trending down.
And a cool way to use this chart is usually when the hedge fund line and the swap dealer line are spread far apart (last year) prices are topping out. And when the hedge fund line approaches the swap dealer line, prices bottom out (ESPECIALLY if the commercial line is becoming increasingly more short--i.e. glut-world).
So how bout this oil rally
This is the seasonal oil trade, glut or not. And now with the hedge funds very long and the producers very short, they are speculating on the seasonal rally that happens very year (smart play, they made money) meanwhile the swap dealers moving shorter because the hedge funds are taking the long trade instead of them (flattening swap dealer curve). So where does this leave this rally? Well...fickle hedge fund managers can abandon this position quickly. This is the "it's dangerous to be long oil" territory from a risk management standpoint. The COT chart to me spells out overbought because of cheap oil and speculation and all it will take is some trigger for hedge funds to dump this long-oil and send things crashing. The more and more short producers get, the less faith they have in oil prices... and that's because they know they aren't cutting production any time soon.
How about this everything else rally then?
If the SPX does not rally soon, to this magic 2060 and onward, and the Fed decision doesn't rally the market into new highs, impatient long-oil fund managers can and will sell off oil alongside their long equities and well... I hate to use the word crash... but it's just that when you dig into the numbers everything on the commodity side looks just as over-inflated as equities do. And for the rest of the market-- well that's hanging on the fed decision. SPX 2060+, it goes to test last year's high. SPX 1980 and below, it's then 1800 and below. If we don't get a sustained rally in the SPX or in oil, it all can go crashing very quickly, and commodities can lead the way (especially if fed policy send the dollar to the moon)
Hold your balls and your trades, don't chase in this no man's land, and just wait until the victor is decided before you make any rash decisions.
And as always, stay liquid my friends.
Submitted March 15, 2016 at 08:40PM by gabriel87120 http://ift.tt/1RMW2T7
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