Oil, Hedging, Commitment of Traders (and stuff)

I wanted to update a post I made a month or so ago regarding oil prices, and go into some further detail because the price of oil is so important to our markets and economy.

First, a detailed study of oil prices in relation to stock prices shows that if oil rises about 75% or more on a year to year basis, that has been bad for stocks over the next 12-18 months. We are definitely in both of those categories currently (high oil, bad stock performance). Anyone could get much more detail by reading The Oil Factor by Stephen Leeb.

My previous post had suggested that oil prices were starting to show technical weakness and possibly some relative topping behavior. Not much has changed since then as far as technical indiactors. However, I wanted to mention some other data that will better clarify the fundamental outlook and see what the "smart guys" are doing.

There is a report published each week breaking down commodity trading by how many (futures) contracts are being held and who is holding them. The report breaks it down into commercial hedgers, large speculators, and small speculators.

Commercial hedgers are the smart guys. They are traders who are trading for large companies and are hedging against future price increases. So Southwest Airlines, or Fedex, etc. who use huge amounts of oil will buy futures contracts locking in today's price of oil which must be delivered to them at some date in the future. They actually want the oil to physically be delivered for business use. They know their business inside and out and tend to buy contracts near low points in oil prices......they are smart.

Speculators do not actually want the oil, the just try to profit from price swings and have no intention of receiving actual oil. Both large and small speculators tend to be worse (or downright bad) at timing the market turning points and understanding the underlying fundamental supply and demand.

I mention this because we are at an interesting point right now. The smart guys are buying lots of oil (to an extreme level) because they obviously expect the price to go up. The speculators have been selling oil to a relative extreme level. That would indicate that oil is much more likely to go up in the near future. However, the interesting thing is that the price of oil is at all time highs while this is happening, rather than at a low point which is historically when you see such a thing. My basic interpretation of this is that we may be in a still developing "bubble" where prices could rise significantly yet before undergoing a true bear market or large correction.

Time will tell, but if you are interested in profiting from this potential move, USO, DBC, and DIG are ways to basically buy oil through the stock market without actually trading the commodity. There are other funds as well, but USO is the most widely used.

Basic conclusion..........treat any pull back as a potential buying opportunity once things look favorable for your trading system again.

Pete