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Time To Squeeze The Short Oil Speculators?

Posted by on Jan 23, 2016

Time To Squeeze The Short Oil Speculators?

Given the accelerated selling in the stock market this week with the Dow down another 500 points mid-session Wednesday stock holders are clearly past the white-knuckle stage. With just 116 stocks advancing and 3077 declining mid-day Wednesday the selling had clearly reached panic levels. The ability of the Spyder Trust (SPY) to close over 2.5% above the low and the positive close by the iShares Russell 2000 (IWM) are encouraging signs.

The slide in crude oil has been relentless with sentiment very negative as many strategists continue to lower their forecasts. According to Saxo Bank  “Speculative short bets are now more than 40,000 lots higher than the last peak in August which was followed by a 25% price jump in a matter of days”.

Also it is worth noting that long positions in crude oil by non-commericals hit a 12 year low in the latest COT data. I have been closely following crude oil for over 30 years and in the late 1980’s I was asked to give a full day seminar for energy traders in Singapore. One point I emphasized with traders then and still find very important now is the action of the open interest. So why is it important?

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The daily chart of the continuous crude oil contract shows that it just “kissed” the 20 day EMA in late November and December before dropping sharply. On the decline from the November high crude lost 20%.

  • Since the December high crude oil had dropped 28% as of Wednesday low.
  • Crude is currently 15% below its 20 day EMA which is one of the largest gaps since August.
  • If the current decline is going to match the drop from May 2015 high to the August 2015 low then the downside target is $26.50 of just $1 above the week’s low (see chart)
  • As noted earlier the sentiment basis the COT data has reached an extreme last seen at the August lows.
  • The open interest has been rising but has recently turned lower suggesting some on the short side are getting nervous. Similar action was seen on August 19th which was just four days before the low.
  • The Herrick Payoff Index, which uses open interest, volume and price, is also starting to diverge from prices.
  • Basis the April contract it will probably take a move above the $31.60 level to really squeeze those who are short crude oil.

The crude oil ETFs like the SPDR Oil & Gas Exploration (XOP) have been leading the market lower as it is down over 20% YTD.

  • It came close to the daily starc- band Wednesday as it had a low of $22.06. The low in 2008 was at $21.28 with a March 2009 low at $21.47.
  • It closed 7.6% above the day’s lows on Wednesday which is indicated by the long tail on the candle chart.
  • Next resistance at $25.50 with the declining 20 day EMA at $27.46.
  • It may have been be a selling climax on Wednesday as volume was triple the three month average.
  • No signs of a bottom from the daily, weekly or monthly OBV.

What to do? Given the high level of bearish sentiment and oversold extremes that I discussed in last weekend”s column “Is Bullishness Low Enough Now?” a good stock market rally is increasingly likely.

The open interest analysis of crude oil makes it ripe for a short covering rally. With the heavy speculator short position in crude and low level of commercial long positions it would not take much to trigger a sharp rally in crude. This will the very negative sentiment and could take the United States Oil Fund (USO) back to the $10.50-$11area. I will Tweet a chart later today of USO and will be updating my analysis on Twitter.