Because of its domestic economic importance, this article begins with a discussion of oil and natural gas, then moves on to copper.
Speculators ("specs") in the futures markets have increasingly tilted, and tilted heavily, to the bullish side on West Texas Intermediate crude oil, or WTI. Is this a bull trap, or are oil prices set to surge again? This has major implications on the U.S. economy and on many energy stocks, and stocks of energy users. Let's investigate one part of the puzzle, abjuring fundamental analysis.
Note in these charts, the green line represents the commercial interests, and the red and blue lines the large and small traders, who comprise the specs. The green line is the sum of the red plus the blue lines.
Here's a chart of the futures shown for one of WTI's competitors, natural gas, courtesy of FINVIZ:
One sees here that new, efficient drilling techniques brought the price of natural gas down to earth. The pattern is one of lower highs without as clear a pattern of lower lows.
Next, here is the multi-year chart on WTI.
There are some striking data points on the above chart. One is that in the giant run-up toward $150/barrel in 2008, speculators were flat. At least on this futures market, the price rose simply because it rose, but it came as a surprise to the speculative community. After the bust, the specs have engaged in a pattern of greater and greater net long positions, as the commercials sold production forward to them. We now see a multi-year indeterminate pattern. The post-Fukushima spike to recovery highs in H1 2011 has been followed by three or four intermediate highs (depending how one looks the chart). All of them have been associated with spikes upward in bullish net sentiment.
Currently, we see record net longs as far back as this chart shows. Yet, the 2011 price high for WTI was higher than the 2012 high, and the 2012 high was higher than the 2013 high. Speculators have been increasingly bullish, but price has lagged their bullishness. That's a divergence. Will it prove important?
The natural gas chart may be of some value in thinking about WTI. The important 2011 price spike in WTI was followed by a major bear market in natural gas after a period of consolidation. It was natural for WTI to follow downward.
The next price spike upward in WTI came early in 2012, associated with increased bullish positioning by the specs. However, natural gas was still trending down, and stayed low for months. Oil's spike again could not be sustained. Did dropping natural gas prices contribute to that failed attempt at a breakout in oil?
Moving on to the current situation, we now see a multi-year record short position by the commercials (bullishness by the specs), despite a relatively restrained price spike in WTI. At the same time, we see a renewed bear market in natural gas. (Note that there is seasonality in natural gas to a greater extent than for oil.)
Since gas is cheap to oil on an energy-equivalent basis, my bias from this comparison would tend to be hopeful that WTI will trend downward again.
Interestingly, the specs are as bearish on copper as they are bullish on WTI.
Here's the FINVIZ chart of copper, showing the speculators all in on the bear side:
The specs are maximally bearish. In this time frame shown, when they have gotten very bearish, the price of copper has hit at least a short-term bottom.
So here's the set-up that I see. Speculators are massively bullish on WTI, for unclear reasons. Perhaps they are buying the story of an accelerating U.S. economy. At the same time, they appear to hate the fundamentals of copper, presumably in association with the recent economic weakness in China and weakness in various emerging countries' manufacturing PMIs.
The charts could break either way, or meander. But whenever I see extremes in positioning in important markets, I take note, because my sense is that sharp moves in either direction may be pending.
My guess is that the persistent weakness in natural gas pricing presents a headwind for WTI's price. There appears to be no shortage of WTI, at least in the short term.
At the same time, my trader's sense is that we have heard just about too much negativity about China, at least for the short run, and I'm wary of a turnaround in the newsflow, at least for a while.
I do not trade futures, but I watch them closely. In this case, looking at the above, I have lowered my oil patch exposure moderately and yesterday bought Southern Copper (SCCO), a strong and out-of-favor copper producer that adjusts its dividend payment to its profit stream. Even its currently-diminished dividend is quite satisfactory, though a further drop in copper prices might force it to be cut further or eliminated.
Conclusion: Two major commodities markets show extreme speculative positioning. This may set up a sharp move in one direction or the other. It may also be a reasonable scenario to wonder if some of the same traders who are long WTI are short copper, and thus the commodities may tend to continue to move in opposite directions. This is the case Thursday morning, as I write this.
Even if one does not wish to trade stocks based on what futures traders are gambling on, the economic importance of oil and copper may make these markets worth tracking in view of the speculative extremes demonstrated in these markets.