Re-evaluating Crude Oil Speculative Positioning

Submitted by Kevin Muir via The Macro Tourist blog,

Over the past year it is amusing how quickly market sentiment has gone from “crude oil will never rise again” to “better buy oil because of, well, just put your reason in here… there are too many to list.”

 Joe Weisenthal from Bloomberg News had a great tweet that summed up the dramatic shift:

Although the market is now all bulled up about the prospects of OPEC cuts, increased global economic growth and most importantly, the Trump border tax’s potential bullish effect on WTI crude oil prices, these influences are all “known” by the market.

All one needs to do is look at the CFTC’s COT (commitment of traders) report to realize the lopsided nature of crude oil sentiment.

Seems straightforward huh? Record high net speculative long positions in crude oil seem to scream disaster in the making.

I am a little embarrassed to admit, but I did apply this sort of superficial analysis to the CFTC COT net speculative positioning report. Yet a conversation between my favourite Australian (and a must follow) PrometheusAM and RealVisionTV’s Raoul Pal about the large increase in net spec longs forced me to open my eyes regarding the problems with this simple chart.

Let’s start with the most obvious error. If the contract becomes more popular, then as volume and open interest expands, there will be increasingly large net speculative positions when measured in terms of total contracts. This absolute number of speculative contracts could give false signals.

If a contract’s volume expands by three times, but the net speculative long position only increases one and half times, then the absolute position of net speculative longs will be sitting at all time highs, but in reality, speculators will not be nearly as bullish.

Therefore the first change we need to make is to measure net speculative positions not in absolute terms, but instead as a percentage of open interest.

When we make that adjustment, the net speculative position pictures changes a little. Yes, net specs are still elevated, but nowhere near the degree when measured in absolute terms.

I wish this was the only problem with my analysis, but there is another factor we need to consider. When net specs hit their peak in 2014, the price of oil was much, much higher.

Another way to look at net speculative positioning is to measure the total dollars of exposure.

This chart shows a crude oil market that is much less lopsided than I previously believed. Over the past five years, net specs have often held larger net positions as measured on a dollar basis.

Now don’t misconstrue my post as an abandonment of my bearish crude oil view. I still hate crude oil and believe the next surprise will be lower rather than higher. But a little weekend thinking has forced me to re-evaluate the true extent of the supposed extreme speculative positioning…