Jul

25

A VeltmanA fascinating game is on today in Crude futures, with algorithmic black boxes sniffing out sell-stops below 121.61, which will mark a new low for summer 2008! Such a game would have not just short-term implications. Yes, it would be enticing to keep shorting until the stops are triggered, thus allowing a later profitable cover. But also, a long-term "chart damage" would be created once the first lower low is marked on this year's chart. The implication of that would play out some time in August when programs would then gear up to be "sellers on a rally," only because of this little "trend change" indication.

George Parkanyi suggests:

I don't know, Anatoly, that's reading in a lot. Even Freud once replied testily that "a cigar is sometimes just a cigar". But I'd love for your scenario to play out, so I can take another profit from my oil short position.

Anatoly Veltman explains:

CFTC's Commitment Of Traders (C.O.T.) report as of 7/22 settlement, published near Friday's close, confirmed our suspicions. For the first time this year, both Large and Small Specs rolled over from Net Long to Net Short in crude! The speculative push is on: to try and trigger sell-stops near $121.61 June low. One should be aware of fragility of such a plan: 1. Crude has fallen two weeks straight on reduced Open Interest (from 1.35m to 1.22m), i.e. over 100,000 Longs already got out and do not have a resting stop-loss order below. 2. Price has entered the area of natural support: 38.2% retracement of 2008 advance and 100-day moving average.

Thus, whether Specs succeed and trigger remaining sell-stops or not - the ensuing rush to resume buying activity should not keep us waiting for too long.

Rocky Humbert analyzes:

In my many years of commodity speculation, the most important lesson which I have learned is humility. The second most important lesson is to look beyond the obvious. And the third most important lesson is that price action leads the fundamental news. In this case, I suggest Anatoly look to all of Nat Gas, Coal, RBOB and Heating Oil crack spreads, and the shape of the yield curve, for far more interesting market information than whether a particular price point triggers some short term or long term stops.

  1. Nat Gas has given back its entire rally since January without so much as a minor bounce. This would equate to Crude moving to 90$/bbl without any meaningful bounce. Coal has also taken out the price equivalent of Anatoly's stop level on the downside.
  2. The gasoline (RBOB) crack spread has been negative or near zero for some weeks now. This is unprecendented for the summer driving season and shows the extent of true end user demand destruction. Refineries will obviously reduce their runs rather than process crude at a negative crack spread. Crude is a completely useless commodity. It's the products that really matter!
  3. The heating oil crack spread, in contrast, remains extraordinarily wide. Some attribute this to Chinese hoarding post snowstorm/earthquake and pre-Olympics. So the gasoline and heating oil crack spreads are giving us contradictory signals. While I'm open-minded on the outcome (although short right now), if I see the heating oil crack start declining, I'll know for sure that it's game, set and match for this phase of the crude bull market, and I'll aggressively press my shorts.
  4. The Crude yield curve recently moved to contango from backwardation. Producers are now motivated to build even more inventories, and this is a self-reinforcing feedback loop. When the crude curve goes into contango, it is predictive of declining prices in the spot contract for the following three to six months.
  5. The price volatility of crude is around 40% now. So, as a pure probability statement, one can easily envision a 40% decline from the "high" and we'd still be in a "secular" bull market! More importantly, given 40% volatility, one would expect daily swings of around $7 per barrel — just as random noise.
  6. I am unaware of any rigorously backtested studies which show that the COT open interest is predictive in crude. They are only a coincident indicator of trend. Perhaps Anatoly has different studies available that he can share?
  7. Lastly, and most importantly, many commodities do trend for good economic reasons. I suspect even Vic and Laurel will concede this point. One can ridicule the trendfollowers but I reckon the good ones have been long crude from $90 and started exiting when we broke through $135.

Right now the entire energy complex appears to be breaking down after a remarkable multi-month and multi year-bull market. If you are buying the dip for a quickie bounce — good luck! But if you hold your positions for weeks or months, as I do — it's frivolous to declare your entire market view based on whether one particular price prints. Markets are far wiser than that.

Anatoly Veltman replies:

Rocky, your observations are very useful. I'm glad to further discussion on short-to-intermediate term Oil - moreover, your view is coincident to Ahmedinajad's "unjustly over-priced!":

  1. What if NatGas next "bounced" big?
  2. Demand destruction and "importance" of only products — agreed.
  3. So short crude based on RBOB; not yet short a second unit based on HO?
  4. The "contango bear indicator" has been obvious throughout NYMEX history; has it been tested over the recent years, since Crude futures (and ETF based on them) became an asset class?
  5. My Elliott Wave log-scale chart allows correction to $50, before Wave 5 ensues.
  6. I am against C.O.T./O.I. techniques' mechanical application. Only a trader with sophisticated understanding of how it confirms/overrules a trading idea should use that coincidental data.
  7. $135 broke one up-trendline — agreed. What put you into a long over $90 through $147.27 — everyone could learn from a detailed explanation!

Rocky Humbert adds:

Anatoly, point by point: 

  1. And what if it didn’t? They call Natgas the “widow maker” for a reason!
  2. Glad we agree.
  3. Philosophically yes. But real life is rarely so easy.
  4. There’s only been one episode where CL swung from backwardation to contango since ETF’s came on the scene. That was Dec 2004 to Dec 2005. And although the nominal price went nowhere, longs lost money net of the roll cost. So, not enough data. But, putting on my bond hat for a second, positive carry really does matter.
  5. Cool. Then let’s stop chatting, you need to call your broker and go limit short.
  6. OK. I think the upstairs/offshore mkts plus the ETF’s have made these stats less useful. Also note that some people think that aggressively buying a heavily shorted STOCK is a way to squeeze shorts and make money. Other people believe that the shorts are smarter than the longs in individual stocks. In all events, I avoid using tools which are open to interpretation. I’m just not smart enough to figure them out.
  7. There are still Donchian systems out there. BUT …. even a blind squirrel sometimes finds a nut too. As a college math book might say, “the proof is left to the reader.” Hence you can decide whether it’s a blind squirrel or a useful system. Vic, Laurel and many readers of DailySpec are philosophically opposed to static systems … and I’d rather remain coy rather than risk being pilloried or laughed at. Let’s leave it at that please.

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