Hurricane trading & currency recap

There’s a longstanding idiom in trading, “Buy the rumor and sell the fact.” The information age has amplified this tendency because we have more information, not necessarily better information. Individuals being what we are, repeatedly fail in our attempts to filter this information accurately. We’ll look at the Commitments of Traders (COT) report’s ability to separate the hurricane-fueled, record-setting speculative investing habits of the heating oil industry’s producers, and update the currency markets.

Roughly half of U.S. produced oil is refined somewhere along the Gulf Coast. Hurricane Harvey followed its anticipated path right up the gut of our major refineries. Hurricane threats in the Gulf Coast act more like floods than droughts when compared to their agricultural commodity cousins. Droughts take a while to set in, while floods are the unstoppable force on the horizon we all see coming. The difference is significant because the perceived threat is much more visceral. Hurricane Harvey led to speculative long positions in heating oil futures based on anticipated supply disruptions. Hurricane Irma, which steamrolled up the west coast of Florida, further bolstered speculative actions. The COT report shows that speculators were long less than 10k contracts at the beginning of August. They set a new record net-long position of nearly 60k contracts less than six weeks later.

We talk about speculators being left, “holding the bag” at the market’s most important turns. The same could happen with heating oil. Commercial producers have set a new record short position on the combined hurricanes’ rally, having sold more than 65k contracts over the same period. The commercial traders’ position has climbed by more than 80k contracts, twice that of the speculators. Commercials dominate the energy markets. Clearly, the commercial heating oil producers expect prices to top out near the recent $1.80 high. This is why the heating oil market looks like the speculators have “bought the rumor” while the producers have “sold the fact,” and also why the speculators will be probably be left “holding the bag.”

Last month we noted how the dollar breached the May 2016 low, and commercial traders have stepped up with a net long position in positive territory for the first time since April 2014. Their buying at the lows also triggered a COT buy signal on Sept 11.  Commercial buying at the lows creates a classic swing trading setup.

Meanwhile, commercial traders have been sharp sellers of British pound futures as they marched to a recent high near $1.37. This was just beyond our May forecast of a rebound towards $1.36. Commercial traders sold 65k contracts in three weeks. They anxiously unwound the record long positions they created following the Brexit decline. Their selling has forced the commercial COT ratio to its lowest level since August 2014, the last significant high in the pound.

A look at long-term trends of commercial interest in the CFTC’s “Commitments of Traders” report.