In our June 4th Research Excerpt, we said: “the smart money, who is in the oil business, is aggressively betting that crude oil is currently over priced at $103 per barrel. If they are correct, and they almost always are, this means that any decline that pushes oil back below $100 per barrel will probably send these very aggressively net long commodity funds heading for the exits, and that forced selling could fuel the decline that the smart money is betting on.

Crude oil prices subsequently peaked a week later, on June 13th, and have since declined by $8.35 per barrel or 8% into the July 15th lows before last week’s tensions in the Ukraine and Middle East triggered a rebound.

In today's report we display and discuss the latest futures market‐related investor sentiment data pertaining to crude oil prices according to a survey of individual futures traders, the current positioning of smart money commercial hedgers, and total open interest in the NYMEX crude oil contract. These data collectively suggest that the June decline in oil prices is uncompleted and amid favorable conditions to extend into at least the latter part of the 3rd Quarter.

Chart 1 measures investor sentiment according to a daily survey of individual futures trader bullishness on crude oil prices, which is plotted since 2011 by the blue line in the lower panel. A corresponding chart of NYMEX crude oil appears in the upper panel.

Chart 1 

The declining red arrow in the lower right portion of the chart points out that these intermediate term‐oriented trend followers are retracting from a June 18th most bullish extreme of 85% bullish or greater, one which the vertical red highlights between both panels show has previously coincided with or closely led what have been the most significant peaks in oil prices during this period.

Moreover, the metric in the lower panel is only about halfway to reaching opposite least bullish extremes (green highlights), which suggests that the current price decline may only be around half completed. 

Chart 2

Chart 2 measures investor sentiment on crude oil prices according to current net positioning by commercial hedgers in the NYMEX crude oil contract via the Commitments of Traders data, which is compiled and published weekly by the Commodity Futures Trading Commission (CFTC). According to the CFTC, commercials are professional entities, in this case typically oil producers or refiners, that use the futures market to hedge their inventory in the physical commodity.

The red highlights in the upper panel point out that the commercials, who are generally acknowledged as being the smart money, reached a record net short (bearish) position in crude oil futures on Jun3 24, after which oil prices plummeted by 8%.

A closer look at the chart shows that, despite this recent sharp sell off in oil prices, the commercials are still maintaining a close‐to‐record net short position of 426,935 contracts as of the latest data. This represents a very aggressive bet by the smart money that oil prices are still overvalued, and likely to continue moving significantly lower in the weeks and months ahead.

Chart 3 

Chart 3 also measures investor sentiment according to futures traders, this time according to total open interest in the NYMEX crude oil contract (which the commercial net position is a subset of). Total open interest is the total number of open futures contracts, both long and short, that have been entered into and not yet liquidated by an offsetting transaction or fulfilled by delivery. Open interest measures near term investor conviction in a price trend. As such, it typically expands in the direction of the trend, and begins to contract once the market decides
that the trend is no longer sustainable. 

The rightmost red highlights in the chart show that total open interest in the crude oil contract contracted below its 10‐day moving average shortly after establishing a new 2014 high on June 20th. This indicates a lack of near term bullish conviction in higher oil prices, as some traders were no longer willing to carry long positions overnight.

The red highlights in the left half of the chart show that similar contractions in open interest coincided with the past two minor declines in oil prices in early March and late April. As long as this contraction in total open interest continues, so is likely to continue the current price decline from the June highs.

Conclusion & Investment Implications

Aside from this week’s geopolitical tensions‐triggered spike higher in oil prices, smart money commercial hedgers are making a record aggressive bet that oil prices are headed lower over the near to intermediate term.

Moreover, individual futures traders are currently retracting from a mid June most bullish extreme in oil prices, which means that their long liquidation is likely to exacerbate the move lower.