In this week’s COT report, most major currencies and commodities remain outside of bullish or bearish extremes. Instead, the only position that looks extreme is long crude oil. Over the past week, speculators have added to their long crude positions, and there are now 679,047 futures and options contracts long the commodity. Given the size of the long crude crowd, even a small pullback in crude oil prices can quickly escalate into a rout. This is shown below:
CFTC COT (futures & options combined) – December 26, 2017
Notable extremes are bolded, and are highlighted when speculator positioning is more than two standard deviations above historical trailing 1-year and 3-year trends.
The biggest changes in net positions this week includes rising crude oil and gold positions, and falling Canadian dollar positions. While long British pounds and short Australian dollar positions were at extremes last week, this is no longer the case.
Crowded speculator net positions foreshadow reversals
Looking at crude oil speculator positioning in recent history is particularly enlightening. One can clearly see that the commodity tends to change directions when either bullish or bearish speculator positions become crowded. On January 12, 2016, long crude oil positions dropped to just 195,086 futures and positions contracts. This was 2.1 standard deviations below the previous 12-month average. On that day, WTI crude closed around $30.50. That ended up being pretty close to WTI’s long-term bottom, and the commodity rallied to $50 by the middle of the year.
Later in the year, long crude oil speculator positions were at a bullish extreme. This time, speculators were long 458,775 futures and options contracts on October 11, 2016. This was 2.3 standard deviations above the previous 12-month average. WTI crude closed around $51 on that day. A few weeks later, crude oil prices fell as low as $43.
An overview of recent speculator net positions and associated 1-year z-scores is shown below:
Speculator net positions and z-scores since 2016
Crude oil fundamentals remain supportive, but going long looks risky
Most recently, long crude oil positions are once again at an extreme as measured by trailing 1-year z-scores. Our sentiment indicator has been suggesting that crude oil has been overbought since mid-November, but this hasn’t stopped the trade from becoming more and more crowded. Crude oil has also rallied since mid-November. Last week, an additional 35,180 contracts were added to the long crude oil trade, and 3-year z-scores are almost at three standard deviations above trailing 3-year averages.
Looking at the underlying dynamics of crude oil demand versus supply, ongoing inventory drawdowns (as per US EIA data) and demand from China bode well for the commodity. Even with sharply higher US oil production (now likely to be more than 10m barrels per day), shale hasn’t ruined the crude oil party just yet. Lastly, crude has been boosted by various pipeline shutdowns (Forties pipeline, Libyan pipeline) as well as political tensions in Iran in recent history. A US dollar rally also looks out of reach thanks to strong GDP growth outside the United States. Our momentum indicators for crude oil also suggest bullish price action. In short, there are many good reasons for crude oil to keep rallying.
This being said, elevated speculator positions are a real short-term risk to the current bull market and should be considered. For traders looking to go long crude, patience is likely to pay off.