Speculators Not Causing Crude Rally

This is my commentary on an article on Marketwatch.com today:

This run-up in prices today is the risk premium due to threat of DISRUPTION of the SUPPLY without any compensating DECREASE in DEMAND! This is still proof that it is supply and demand that is driving the market. Sorry to disappoint you. Fortunately, the "buy the rumor, sell the fact" will probably come into play once the Israeli threat to Iran passes. Then, perhaps prices will come back down somewhat.

Speculators in the market represent only 20-25% of futures trades, according to CFTC data. Furthermore, at any given time, speculative traders are evenly divided between longs and shorts. To suggest that only 10-12% of the market participants have that much control is neither realistic nor factual.

So Who IS driving this rampage today?

Commercials, who take physical delivery, represent 75-80% of NYMEX trades. They take physical delivery. These are the ONLY true long-only participants in the market. Thus, they have greatest influence on prices. They are also the market participants who represent OUR demand for oil as they hedge to obtain guaranteed prices (hence the contract) in an environment of a potentially catastrophic risk to supply. In other words, they are US!

Even large speculative funds MUST eventually sell the market in order to avoid taking physical delivery. They HAVE to; they have no choice. Thus, every long trade requires an off-setting short trade. Again, they have no choice. They MUST short the market. If speculative funds were the driving force behind higher prices, then prices would plummet near expiration as the specs ran for the exits to avoid delivery requirements at contract expiration. This is proof that the specs don't drive prices higher, despite our desire to be tantalized into blaming an easy target. If anything, their influence is a moderating one that would drive prices DOWN. In fact, CFTC data in the past few days has shown that this was a short-covering rally, as speculative shorts were forced to buy to off-set their short trades. We must keep in mind that it was these speculative shorts who drove prices DOWN over the past two weeks. If they hadn't shorted the market over the past few weeks, prices would have continued going higher and higher! We probably would have already hit $150/barrel for oil. We should be thanking them, not cursing them!

The only market participants that can avoid this off-setting short trade are the "commercials", who buy to take physical delivery. Only they can take a long position and NEVER off-set it with a short trade. This has an influence that forces prices inevitably higher.

By limiting participation of speculative traders in the futures markets, we would be literally fueling the very fires that we seek to quell. This is because we would limit the anti-long (short) influence of speculative traders. We would also limit the market to participants who are the ONLY ones who can ALWAYS be long -- the commercials. This would empower the LONG-ONLY commercials, consolidating even greater control in the hands of the very big, and very few commercials. Thus, prices would HAVE to go higher.

The only TRUE solution, of course, is to increase domestic supply of our energy needs so that risks to disruption of global demand don't impact the supply, and thus, the price of oil. Unfortunately, I see little political will to deal with this in Washington. It is just too easy to point fingers of blame elsewhere.

We need to be careful what we wish for. We'll be much worse off if we get it!

Crude Oil May Hit $10 Limit Today

While prices are still almost $2 from it, traders need to keep in mind that crude oil does have a lock limit of $10, up or down. In my time in trading, it has never been reached. However, the two-day run-up in prices is so severe that it is possible crude could reach its lock limit price. We are currently trading over $136/barrel.

From the NYMEX website:

Maximum Daily Price Fluctuation

$10.00 per barrel ($10,000 per contract) for all months. If any contract is traded, bid, or offered at the limit for five minutes, trading is halted for five minutes. When trading resumes, the limit is expanded by $10.00 per barrel in either direction. If another halt were triggered, the market would continue to be expanded by $10.00 per barrel in either direction after each successive five-minute trading halt. There will be no maximum price fluctuation limits during any one trading session.

Corn Sets New Record High

Corn has also achieved a fresh new all-time high price today at 6.63 1/4.

"It's all about the weather. People have had to replant fields a third time and it's completely unknown how the flooding is going to affect yields," said Elaine Kub, analyst with DTN in Omaha.

Fresh New High for Crude Oil

Crude oil has reached a fresh new all-time high price above $135/barrel. This is an increase of more than $13.50 in two days. My guess is that this will contribute to a fresh round of selling in the equity markets.

Three Waves of Market Reaction

In this chart, we see clearly the three waves of market reaction to surprise shocks in the world of finance. I am referring to three waves of orders flowing through the futures exchanges, not Elliott Waves. I have marked each wave near its end above.

Elliott Wave Theory

There are also larger waves on higher time frames. While I am not an adherent to Elliott Wave Theory, I acknowledge that it may have some validity. It certainly has many devotees. I have a an excellent book on the subject that was graciously gifted to me by the author. However, it is so incredibly complex (waves within waves, etc.), and so subject to interpretation, that it tends to be more art than science, in my opinion. It also takes very practiced practitioner to be good at it. The waves I am referring to in this chart are not Elliott Waves.

Three Waves of Orders

Phantom of the Pits refers to three waves in his book, Phantom's Gift. This chart shows three waves of selling today as different market participants reacted to the various data.

1. Wave #1 occurred today when the data was released and traders responded immediately to the data. This wave often occurs as professionals, and especially floor traders, react immediately to breaking news.
   
2. Wave #2 in this chart occurred when the stock market opened and investors were able to respond to the data. This wave also often occurs as orders flow into the pits from those who have belatedly heard about the recent news.
   
3. Wave #3 occurred in this chart when retail investors (the general public) began to catch wind of market sentiment and began to react. Often, this will occur when brokers call their clients and make recommendations. These retail investors will then respond to market sentiment based upon their agreement or disagreement with brokers. This wave often occurs when the public hears of the recent news, and is often the strongest wave.
   

Note that often, wave #3 occurs just at or near the market apex or, in this case, the nadir of the market's reaction to news. Sadly for most retail investors, it is often the turning point of the market.

Phantom of the Pits refers to the three waves in his book, Phantom's Gift, but doesn't explain in great detail. He does say that the safest and most reliable place to enter the market is at the earliest stages of wave #2. He also implies taking profits on wave #3 and positioning against the public by fading the market in wave #3, which is when volume is the strongest but will soon lose steam. This may seem like a contradiction, but it's not. The third wave, while strong and often causing new highs or lows, is also the thinnest. This is the best time to prepare for a counter-trend move or reversal. I'm not familiar with any books on the subject of this phenomenon of the three waves of orders, except Phantom's Gift. If you do, please contact me by writing a comment attached to one of my posts in my other blog. Thanks!

Investors Flood Back to Treasuries

Meanwhile, investors are rushing for the equity exits. They are rampaging back into treasuries as a safe haven.

Rogers Commodity Index Gaps Higher

Even the broader Rogers Commodity Index futures have gapped forcefully higher today. This index is much broader than the GSCI, and contains less energy futures. It demonstrates that the Dollar's plunge is sending all commodity prices much higher!

Gold, Too, Goes Parabolic

Dow Drops Nearly 300 Points!

Grains All Firmly Higher

Corn (left), soybeans (middle), and wheat (right) are all strongly higher today. By this fall, we may be seeing shortages, and we will almost certainly be seeing higher prices!

Oil: $12+ Rise in Two Days!

Crude oil prices have risen so fast in less than two days that we have now reached levels only $1 from the all-time high of $135/barrel.

Every time we fill up at the gas tank, we need to remember that both Barack Obama and John McCain are devout believers in the global warming religion. Is this the value system we want in the White House? If so, $4 gasoline will soon be $8 gasoline!

STAGFLATION!

Lead by crude oil, commodity prices have exploded today. And we haven't even heard of any threat to the Gulf of Mexico oil fields due to a hurricane yet!

How ironic that this whole round of inflation was ignited by Jean-Claude Trichet's threats to raise interest rates to combat inflation! The chart here is the daily and 4 hr charts for the Goldman Sachs Commodity Index futures. Note the immense gap upward today on both time frames! This is not a common phenomenon in futures.

Meanwhile the shock of higher unemployment has sent stock indexes into a tailspin. This, in turn, is sending investors back into treasuries and forcing interest rates lower, which is pummeling the value of the U.S. Dollar (see chart above). And the falling Dollar is raising the fear of inflation even more. What a vicious circle!

Stagnating economy + high inflation = stagflation

Unemployment Rises to 5.5%

The U.S. unemployment rate has risen a surprising .5% in one month.

The combination of crude oil prices and unemployment rate is pummeling stock index futures this morning.

Morgan Stanley: $150 Oil by July 4th

Morgan Stanley is predicting crude oil at $150 in less than 30 days! That's going to hurt!

Crude Oil Rockets $10 in Two Days

Crude Oil has risen from $121.61 at 9:30 pm EST Wednesday night to $131.56 this morning, just five cents shy of $10.

Stocks Recover, Go Higher!

I am surprised, but the stock indexes have not only recovered from the latest crude oil shock, but moved higher still! What a day! Long again, friends!

Crude Oil Can't Be Contained

It's no wonder stocks have plunged! Crude oil has take off again! Crude oil is crashing the stock rally party today! After holding support well above $120, crude oil bulls have stampeded higher again. Crude oil has surged $6 today alone!

This may have also fueled the fire of higher corn and soybean prices, since the two seem to follow crude oil when it moves higher! They're fuel after all, not food, anymore! This bull trend could really gather steam if poor crop weather continues to fuel corn and soybeans higher while the threat of a hurricane adds moment to record crude oil prices!

It could get ugly!

Go Short, Young Man!

As a trader, I really don't care what direction the market goes. I'll just go with it! The whole idea is to go with the flow. After a nice long trade with the bull run, now the bears are in charge. I'm with you!

Corn, Soybeans Approach Limits

The blue lines above are lock limits. The dotted blue lines at the bottom are yesterday's close.

Corn - may reach lock limit

Soybeans

Shooting for 200 on the Dow

I was hoping we'd make 200 points on the Dow today, but now that the stock indexes have begun to manifest some weakness, it looks like we might not make it with 2 hours left on the day. This has been a good day for trading both stocks and grains. What a bull run!

New Record High for Corn

Corn has reached a new all-time record high today over $6.40/bushel. As expected, corn and soybeans have begun what may be a new bull market, largely due to weather-related growing conditions. Cool, wet weather is to blame. Food prices will probably rise as a result. Perhaps even shortages could be on the horizon.

Weather Front and Center

I have growing concerns that the grain-growing regions of the United States are too wet. This daily chart for soybeans shows a Bollinger Band break-out yesterday, a key sign of a bullish trend, following two months in a tight trading range. Cool spring weather and wet, rainy conditions are beginning to increase sentiment that a bull market in grains may be starting to build. We are now at a crossroads where it is almost too late to plant some crops, and others are showing signs of the seeds (already in the ground) rotting, requiring replanting or giving up on this season. Even with the resurgence of the Dollar, poor weather may outweigh the strength of the Dollar and push grain prices into a new bull trend.

What Happened to Reports of High (or Should I Say "Low") Rice Prices?

The price of rice, like many commodities, has collapsed in recent weeks. Prices for rough rice futures have declined about 25% since mid-April. Those who try to blame traders for the high price of food commodities tend to ignore the fact that very little rice is traded in futures. There are so many different varieties of rice that there are very few rice futures. How then can speculative traders be blamed for the price of rice?

This chart is for rough rice traded on the CME, which is the most liquid rice futures contract in the world. It has open interest of only about 6,800 contracts for the July 08 contract. It is so thinly traded that I won't even touch it! Contrast that with an average of between 500,000 and 600,000 contracts of open interest for the July 08 corn contract. That's 100 times as much! And yet the price of corn has been dead flat for two months!

As can be easily seen in this daily chart, rice is in a downtrend! This is no mere correction, as with crude oil. This is a confirmed downtrend! Why doesn't the media report this fact? When was the last news media report that talked about the 25% decline in rice prices in the past 45 days?

Eurodollar Futures Also Highly Liquid

This chart for the daily Eurodollar futures is also extremely liquid, often with more than 1.5 million contracts of Open Interest. The margin requirements are fairly low, being roughly comparable to the treasury futures. I know very little about the Eurodollar, but watch its movements nevertheless. It apparently represents the interest rates paid by banks on CD's outside the United States on US Dollar deposits. It tends to mirror the activity of the LIBOR futures, but is much more liquid than LIBOR. I am also hoping that there will eventually be an ETF to trade the Eurodollar (not the Euro or EURUSD Forex) futures. The Eurodollar is an interest rate futures vehicle, not a currency trade. Here is what the CME website says about the Eurodollar:

The Eurodollar futures contract is the most widely traded and versatile interest rate futures product in the world. It provides a valuable, cost-effective tool for hedging interest rate fluctuations on Eurodollars – U.S. dollars deposited in commercial banks outside the United States. Eurodollar deposits play a major role in the international capital market, and have long served as a benchmark interest rate for corporate funding.

Dow Plunges Back to Negative Territory

Wow! What a day to trade. The Dow futures have now relinquished all their gains for the entire day and are in the red for the moment. This has occurred in reaction to Fed Chairman Bernanke's speech this afternoon at Harvard University. I have noticed that the stock markets usually do not reaction very positively to the Fed Chairman's speeches. The S&P 500 also have give up its gains. However, the NASDAQ and S&P Mid-Cap futures are still in the black for the day.

Another Confirmed Correction or Downtrend

This daily chart (above) is a futures vehicle that I discovered a few weeks ago and have been following. It is the Rogers International TRAKRS futures. Like the GSCI (Goldman Sachs Commodity Index) futures, it tracks a broad index of 35 commodity futures balanced in energy, agriculture, and metals. However, unlike the GSCI futures, the Rogers TRAKRS futures are quite liquid, having Open Interest of more than 250,000 contracts. That's very liquid! There are probably fewer than a dozen commodity futures that have that volume of liquidity. Hence, it may be a good one to trade on the longer-term charts. It also appears to have broader commodity components than its GSCI sister. The GSCI contains 24 futures and is oriented toward the most liquid ones, but is heavily weighted toward energy-related, and especially crude oil (more than 50% of the total index, the last time I checked), commodities. Hence, the GSCI futures (daily chart below), with the collapse in the price of crude oil, show a stronger downward slope at this time, than the Rogers Intl TRAKRS futures. I would like to find an ETF that trades the inverse (ie., takes a short position) of the GSCI, but I am not aware of one at this time. Buying such an ETF would be a good way to short crude oil. (I am aware of the DUG ETF, but DUG shorts oil companies, not the futures.)

Crude Oil Confirmed Correction

As if this were news, crude oil has been in a confirmed correction since May 28th, which is now trading below $123/barrel, more than $12 from its recent high of $135/barrel just two weeks ago. Note the heavy volume-based selling on the Klinger Volume indicator. This may be due to clogged unloading terminals world-wide as tanker ships (being used to store crude oil) rush to port to try to unload their costly cargo. This phenomenon was predicted two weeks ago in John Mauldin's newsletter that I mentioned (and provided a link to) on this blog.

Iranian Government Storing Oil in Tankers?
The Iranian government had parked crude oil off its coasts in tanker ships, renting most of the world's available tanker capacity, in anticipation of yet higher crude oil prices. Very astute! (Strange, however, that they were simultaneously trying to blame speculative oil traders for higher prices while speculating on higher prices themselves at the same time with this stunt. I think the word for this is hypocrisy.) When prices collapsed due to free market forces, while they were paying about $100,000 per month, per tanker, to store crude oil, Mauldin predicted that they would all rush to port immediately to try to dump their cargo at the best available price, potentially causing a (temporary) glut of crude oil and a resulting collapse in prices. This chart confirms a correction in the price of crude oil. I consider this a correction, not a downtrend. In other words, it is likely to be only temporary. I have no idea how low it will last, but I expect it to be temporary. May it last a long time!

Divergences Form, Prices Collapse

Look at the divergences that formed on these charts. They are depicted in these two charts as heavy red downward-sloping lines in the 2nd and 4th panels of both time frames shown here. The 2nd panel shows bearish divergences on the Klinger Volume indicator, and the 4th panel shows divergences on the MACD. Prices have subsequently collapsed on the Dow! Interestingly, however, while prices have collapsed on the S&P 500 Index and Dow futures, prices have only consolidated on the NASDAQ and S&P 400 Mid-Cap futures. The Dow tends to closely mirror the S&P 500, while the NASDAQ and S&P Mid-Cap also tend to mirror each other. Each of them tend to have distinctive characteristics of their own.

Tick Charts Have Different Values

If you examine the charts closely, readers will also see that I use different tick values on the tick charts for each of them. I do this, adjusting each one from time to time, until the charts become more orderly and smooth. Today, I am using 100 tick charts for the Dow, 50 tick charts for the S&P Mid-Cap, 150 tick charts for the NASDAQ, and 250 tick charts for the S&P 500. For some reason, the S&P 500 is the most difficult to find adjustments that result in smooth charts, even though it is by far the most liquid of the stock index futures. I suspect that this may be because the S&P 500 has more trading activity by amateurs, but I really have no proof or evidence for this opinion. I just know that there is more erratic price behavior (market noise) for the S&P 500 futures. These tick values may all change tomorrow. I examine and adjust them constantly, sometimes more than once a day.

Hints Toward Higher Stocks

I will often look at other stock index futures for hints of what my trades will do. Here are two. Based upon what these two charts are doing, what would you expect the Dow futures to do? My instinct (bias) for stocks to reverse downward, as I mentioned in my last post, may have been mistaken.

Divergences May Form
However, if prices on these two indexes move only slightly higher, then divergences are likely to form on some indicators, suggesting bearish reversals. Divergences on the Klinger Volume indicators, MACD, or Bollinger Squeeze indicators, are signs of waning momentum and eventual reversal. Astute traders are always looking for them. In the futures markets, it take much more capital to push prices higher, while it only takes a lack of new buying interest for prices to collapse and head lower. I believe I learned this from reading John Mauldin's free weekly newsletter. (This fact also suggests that speculators don't have the power to send prices higher, as suggested by those who would blame traders for higher commodity prices. They ascribe to us too much -- undeserved -- credit. )

S&P 400 Mid-Cap futures

The CME is eliminating the Russell 2000 Index futures following the Sept 08 contract. They are recommending that traders switch to the S&P 400 Mid-Cap or a few others mentioned on the CME website, alternatives to the Russell 2000 futures.

NASDAQ Index futures

Dow Bounces

As explained in my last post, the Dow has found support at the EMA on the 15 minute chart (far left) and the Lower Bollinger Band on the 3 minute chart. It remains to be seen if this will result in a resumption of the Dow uptrend, or a temporary consolidation, most likely to be followed by a downturn. If the bulls can't push prices substantially higher (than the previous high), then a downtrend is likely to result. My gut tells me that prices will most likely consolidate for a time and then move lower, but I am trying to be unbiased in this regard. That way, I can be open to whatever market forces are trying to tell me. Exciting stuff!

Shorted Dow

My last post mentioned conditions under which I would short the Dow, which have now manifested themselves. However, prices are close to the 15 minute EMA (left chart), so I am anticipating that prices will find support near here, at least temporarily. If prices move through that EMA and remain below the previous highs, I will plan to go short again. This conflict will probably result in consolidation in this range until this conflict is resolved by either the bulls or the bears. This is hinted at on the tick chart (right) as well as potential dynamic support by the Bollinger Bands on the 3 minute chart (middle). This would be a likely place for prices to rebound higher to resume today's uptrend, or to merely consolidate.

From my experience, however, one never knows which side will win out. With all the worry troubling the stock markets these last few days, there has been a somewhat bearish sentiment lately, as manifested on the daily charts (not shown). However, with Bernanke's statements yesterday and bullish economic data today, the bulls might very well win out. I must be prepared for anything!

I have noticed that stock index traders tend to have very short memories. Morose sentiment one day often gives way to ecstatic sentiment the next day, resulting in manic-depressive movements in the stock indexes. And that's fine with me, because it provides the momentum, liquidity, and volatility needed for profits in the futures markets.

I will continue to buy and sell based upon Phantom's Rule #1 and Rule #2, using my entry, add-on, and exit points, as long as these charts continue to trade with smooth, clean trading conditions. I suppose that only a trader could view this apparent chaos as a thing of artistic beauty! But to me, that's what they are!

Stocks Solidly, Reliably HIgher Today

Contrast the previous charts in my last post with this intra-day chart of the Dow futures today. It is solidly higher and charts are trading with excellent reliability. Here are the 15 minute and 3 minute charts:
Even the tick chart is smooth and reliable, even when the market shows some downward movement, as in this chart. I won't short this market until at least one higher time frame closes below the Exponential Moving Average and I see at least one fractal with a lower low and a lower high on the tick chart. I will also watch the next two higher time frames (15 and 3 minute) for dynamic support/resistance in the form of the EMA and Bollinger Bands. I'll be waiting for the chance to go short!

Little Gain for Grains

The grains just can't seem to hold their gains today. I am continuing to trade stock index and treasury futures. There is a tremendous amount of conflicting data in the grains today. Oil prices have dropped following the weekly EIA data, which has a bearish impact on corn and soybeans. However, a worsening stand-off in Argentina between farmers and the socialist government, combined with a cool, wet spring in the grain belt of the United States, would continue to build a somewhat more bullish sentiment. Conflict between data, both fundamentally and technically, tend to result in stagnant prices and low volatility. The daily charts for both corn and soybeans reflect this stagnant sentiment. Above is the daily chart for corn, but the soybean one looks quite similar for the past 60 days. Grain prices are stuck within a narrow range trading scheme for now.

Likewise, the intra-day chart (below) for corn is similarly stagnant. Yesterday's settlement price is the dotted white line, and corn is only one cent away from that price for the moment. It's not even worth trading! Wheat and soybean prices are also struggling to maintain any prices gains today, with prices of all three within six cents of the opening price. With a limit of 70 cents for soybeans, this is hardly even noteworthy. I will continue to monitor activity, but trade stock and treasury futures for the time being. Stocks are solidly higher today, but seem unconvincing, so both long and short trades seem to be in order.
Corn Intra-Day

Soybeans Intra-Day -- Very Ugly to Trade!
The lesson here, of course, is that as a trader, it is always wise to seek out the trades that show good activity that shows some semblance of reliability. Trading charts that are erratic and unpredictable can only be destructive of a trader's account. The futures markets have tremendous power to devastate a trader's account if we take the markets too lightly. Do so at your own peril!

Grain Bulls Emerge from Hiding

Surprise: Both Stocks and Treasuries higher!

I am accustomed now to seeing treasuries and stocks move in opposite directions. Imagine my surprise today at seeing that both stock index and treasury futures are modestly higher. Good news on economic data today have pushed stocks higher, while recent interest rate moves above 4% have resulted in the buying of treasuries for yield, especially in light of renewed worries about the financial sector. Ironically, this has pushed yields lower again.

Grains Open Stagnant

Following Fed Chairman Ben Bernanke's statement yesterday that the Fed will now take seriously the devaluation of the Dollar and cease it's interest rate cutting cycle, commodities are moving broadly lower. Talk is, ultimately, just talk. It remains to be seen whether talking the Dollar higher will be seen as supportive of the greenback, but it is certainly welcome news indeed. Now, if we can just get Congress to stop spending...

Grains have opened stagnant this morning, but slightly higher. If the Dollar rebounds with any strength, fund selling of the grains may be the result, possibly sending prices lower. Could a downtrend in grains be the result? It seem hard to believe as long as demand remains strong and cold, wet weather conditions continue into the grain growing season.

WAMU, Wachovia Worry Stocks

Good volatility in stocks today to the downside, as worries in the financial sector once again cause stocks to swoon. More flight to safety is driving down interest rates with heavy buying in the treasuries.

Wet Weather Risks Growing Grains

The grains are universally stronger today, after continuing wet spring weather is starting to worry the market regarding the vitality of this year's grains crops. This chart for corn is representative of the three major grain futures this morning. Corn has rebounded so strongly today that the weakness shown last Friday has completely dissipated. The continued farmer strike and break-down in talks with the government in Argentina are also providing price support for soybeans. Short covering might possibly also be a contributing factor today.