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Caution For Crude Oil

02/01/05 08:57:25 AM
by Kevin Hopson

Trading sentiment could indicate a top in crude oil prices and the possibility of a pullback in the near term.

Security:   $WTIC
Position:   N/A

One thing I like to look at on a weekly basis is the "Commitments of Traders" report, which is put out every Friday by the Commodity Futures Trading Commission (CFTC). This report shows long and short positions for commercials and noncommercials as of each Tuesday.

Commercials are those traders who actually have a physical stake in the commodity. Because commercials conduct detailed analysis of the market, they are often considered the smart money (or a leading indicator). Noncommercials tend to be speculators. In other words, they don't have a physical stake in the commodity. As a result, they use the futures market strictly as a trading tool. Because noncommercials like to follow the momentum (trend), they tend to be a lagging or contrarian indicator.

Figure 1: One-year chart of net commercial position vs. light sweet crude price
Graphic provided by: Excel.
This brings me to last week's COT report for crude oil, which shows traders' positions as of Tuesday, January 25. To summarize, noncommercials increased their net long position by nearly 18,000 contracts, while commercials reduced their net long position by nearly 23,000 contracts. In fact, commercials now have a net short position (more than 18,000 contracts) for the first time since October 26, 2004. Because commercials tend to be a leading indicator and noncommercials tend to be a contrarian indicator, last week's report indicates a significant bias toward lower prices in the near term.

If you look at the one-year chart, you will get a better feel for what I am talking about. Just to note, the chart is backward, meaning that you have to look at it from right (January 2004) to left (January 2005). Note how crude oil prices continued to climb last year as commercials' net short position continued to shrink. This is typical, given the correlation between the two. However, note the recent reversal in the trend, in which commercials went from a net long position of nearly 30,000 contracts to a net short position of more than 18,000 contracts. Because of this, I would be cautious on crude oil prices in the near term.

Kevin Hopson

Kevin has been a technical analyst for roughly 10 years now. Previously, Kevin owned his own business and acted as a registered investment advisor, specializing in energy. He was also a freelance oil analyst for Orient Trading Co., a commodity futures trading firm in Japan. Kevin is currently a freelance writer.

Glen Allen, VA
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Date: 02/01/05Rank: Comment: Commercials have been wrong all this while as displayed in your chart and hence I would like to call them as the contrarion indicators. When they had the highest short position OIL zoomed like anything. When they went long, it topped out. So, now that they are going short again OIL is going to have a rising bias. Good Luck and thanks.
Date: 02/02/05Rank: 4Comment: 
Date: 02/05/05Rank: 4Comment: 

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