Thursday, April 14, 2011

A Lot of Speculative Money in the Oil Pits

Rising oil and gas prices are a hot topic at the moment, and we are following the action very closely. Oil prices have spiked recently based on developments in the Middle East, a lower dollar, and what looks like a healthy dose of flat out trading for profit. We believe that oil over $100/barrel is worrisome, but that the rate of change in price is the metric that will likely be the difference between cracking the economy and simply being a temporary nuisance. Currently the rate of change in oil is close to +30% on a year over year basis. Some analysts we follow believe this is close to the cracking point for economic growth and others believe it’s somewhere closer to +100% year over year, so there is room to debate exactly what the choke point will be. We are concerned, but don’t think we are there quite yet.

For those looking for an oil correction to refresh market enthusiasm, one data point analysts have been pointing to lately comes from the Commitment of Traders (COT) report. The report separates commodity trading activity into different categories. Generally large businesses that deal in oil commodities are called hedgers/commercials, and they are considered the “smart money” that hedges their exposure to the physical commodity as trends become stretched and euphoric. Another category is called large speculators, and they are typically considered the “dumb money” that will chase a trend and get most bullish right before the trend ends. The good news is that the latest look at the COT report for oil shows the dumb money has loaded up, and the smart money is very bearish. Let’s hope for economy’s sake that the smart money is indeed smart again...