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Capitulation Not Over in Crude Oil

Chart In Focus
December 05, 2014

Crude oil prices had a seemingly exhaustive washout selloff following the Nov. 27 OPEC meeting.  Oil bulls had been hoping for a production cutback at that meeting, but Saudi Arabia successfully led an effort to oppose such cuts. 

But the message from the Commitment of Traders (COT) Report data is that the washout is not yet complete.  An exhaustive move like what we have seen should produce capitulation among the small speculators, but instead the readings from recent weeks showed them them rushing in to buy.

Traders’ positions are reported each Friday in the COT Report, and they are broken down into 3 categories:

Commercial traders are the big money, and presumed to be the smart money.  They are “engaged in business activities hedged by the use of the futures or option markets.” 

Non-Commercial traders are ones who are not engaged in such practices, but who have large enough positions to merit individual reporting of those positions.  Think hedge funds.

Non-Reportable traders are those whose position sizes are small enough that the CFTC deems them not worth reporting individually.  They are the small speculators, and reliably considered to be the “hot money”. 

This week’s chart looks at the Non-Reportable traders’ net position in crude oil futures.  These traders tend to get more net long as prices move higher, and they get scared out or go short as prices go lower.  Generally speaking they have a bias toward the net long side, and so any time they actually go net short, it is usually a sign of a bottom for crude oil prices. 

Given the amount of the drop in crude oil prices, it would be reasonable to expect these traders to get shaken out of their long positions.  But that is not what they have been doing.  The “buy the dips” mentality was still active.  With the COT Report released on Friday, Dec. 5, they are finally starting to make more of a move to unload their long positions, but they are still not yet back to neutral or even net short, which is what it should take to mark the bottom of this decline.  

The COT Report is issued every Friday, and we feature a discussion of the relevant insights from that data every Friday in our Daily Edition

This oil price decline actually ties into the recent Hindenburg Omen (HO) signals which were triggered this week.  I was just on CNBC on Dec. 4 talking about the Hindenburg Omen, and you can see that interview here.  One point to understand about that video is that headline writers like to spice things up, and in ways not necessarily consistent with the actual story, or with the views of those who are interviewed. 

The reason why the oil price decline is related to the Hindenburg Omen is that HO requires seeing both New Highs (NH) and New Lows (NL) exceeding a certain number of issues on the same day.  There are also some other requirements.

A cursory review of the list of stocks making new 52-week lows shows a lot of stocks with the words “drill”, “energy”, or “resources” in their company names.  Were it not for the concentrated damage to energy stocks resulting from the oil price slide, we would likely not be seeing an HO signal now.  Not all HOs end up seeing a big market collapse, but they do tend to show up ahead of every big market decline so they are worthy of some attention.  To get a big slide now, the stock market is somehow going to have to fight off the bullish forces of positive seasonality, plentiful liquidity according to the breadth numbers, and more QE coming from other countries’ central banks.  Plus we are now in the year following the mid-term elections, which is nearly always an up year. 

That is a tough package of forces for the stock market bears to fight against.   

Tom McClellan
Editor, The McClellan Market Report

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