Usually when CFTC data shows a big speculative position, it is easy to spot the corresponding mood amongst traders. For example, take the current situation with the Canadian dollar. There are record net speculative shorts, and that bias is obvious amongst hedge funds and other professional traders.
However, over the past few years, I have been puzzled by the building of a massive record net long speculative position in the WTI crude oil market.
The monster speculative long position doesn’t correspond to the general attitude amongst traders. In fact, without looking at the data, I would argue most specs are negative towards crude oil. The data does not jive with my anecdotal evidence.
I have written about the problems of solely using net contracts as a measure of speculative positioning before (Re-evaluating crude oil spec positioning). Increases in open interest, and dramatic changes in the price of the underlying asset can make some of these contract-only indicators less effective. This is why experts who focus on CFTC Data, often use net position as a percent of open interest. Adam Collins at Movement Capital has created a terrific website called Free COT Data that uses this sort of analysis. For those interested in CFTC positioning, I highly recommend Adam’s site.
When we transform net crude spec positioning to a percent of open interest, the recent rise does not seem so scary.
Yet I don’t think that completely explains what is going on.
For 25 years, the net crude oil spec position sat in a range.
Then in 2010, it broke out, and has been rising steadily since then.
Now maybe there has been a whole raft of new speculators entering the crude oil market. Maybe hedge funds are secretly long gobs of futures. I don’t know for sure, but I somehow doubt it.
If they were long tons of futures, I would expect to see them doing what they do with all their other positions – jumping on TV touting their idea, or writing up reports about why oil is going to $100. Sure there is the occasional crude oil bull, but nowhere near what you would expect if they had a record long position.
I don’t buy that this increase in net spec longs is a traditional increase in speculation. There is something different about it.
I don’t have any answers. But I wonder if we are missing a new player that may have entered the market.
I am not sure how China would be classified if they were to buy futures, but I think there is a decent chance they might not be classified as a hedger.
Since the 2008 credit crisis, Chinese crude oil imports have increased from 11.5 million metric tonnes, to over 35 million.
We know that over the past decade China has been ramping up their SPR (Strategic Petroleum Reserve). What if they are also trading crude oil futures?
It might explain the recent massive expansion in open interest and net speculative long position.
I understand the bear argument that crude oil is about to roll over due to the weak longs, but what if they are misinterpreting the extent of speculative long positioning?
There is no doubt that the supply side story is bearish. There is a wall of crude oil out there.
But what if the demand side surprises to the upside? What if everyone is underestimating China’s appetite? I don’t know about you, but if I were a Central Bank with too many U.S. dollars, I certainly would be selling the fiat currency and buying some real assets. And if you think about it, nothing is a better real asset than crude oil. It is storable, and most importantly, it represents a unit of energy that is the basis for man’s unbelievable productivity. Take away crude oil and see how many houses, skyscrapers, etc. are built. Take away crude oil and see how you get your fresh vegetables, or even your summer hamburgers. Crude oil is in the price of almost everything we build and consume.
China buying crude oil as a way to diversify their US dollar holdings makes complete sense. And don’t forget, China is not like Bank of Japan or the Federal Reserve. They aren’t going to announce their purchases ahead of time.
I know this theory is a little out-there. But I look at the recent expansion of crude oil net positioning, and it just doesn’t reflect what I see in the market. China as a big silent buyer is a much more plausible explanation than the fact hedge funds are net long record crude oil because they are so bullish.