Rudi's View | Jun 26 2008
This story was first published two days ago in the form of an email sent to registered FNArena readers.
By Rudi Filapek-Vandyck, Editor FNArena
“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”
(Charles MacKay in Extraordinary Popular Delusions and the Madness of Crowds, 19th century)
“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”
(Sir John Templeton)
I find it fascinating how different people can look at the same object, yet see so many different things. The chart below was used by analysts at Barclays Capital this week in support of the view that Barclays, and other financial investors, could not possibly be held responsible for the recent surge in the price of crude oil. The chart clearly shows how speculative positions have been gradually wound back since April as the price of crude oil continued rising into uncharted territory. The logical conclusion is thus: market fundamentals, not “speculators” are to blame for crude oil’s stellar price rise.
I’ll tell you what I see on that same chart. I see each and every move upwards for crude oil futures since January last year (not this year!) being mirrorred in the build up of speculative net “long” positions in the futures market; up until the end of March when oil hit US$110 per barrel. Reaching the initial peak at US$110, it has been argued, was always more of a market technical move, predominantly caused by professional traders covering their market positions (which seemed 100% out of the money beforehand) than any real change in market fundamentals.
What happened after that doesn’t necessarily mean only contracts closed between oil producers and their customers further pushed up prices to near US$140 per barrel. The loopholes that allow pension funds, and speculators, to participate in the oil futures market without being recognised as a “financial speculator” have now been widely recognised and documented.
In addition, and this is quite an important point, the chart below does not show the total number of futures contracts but the net position in the market (the difference between long and short positions by speculators). I know from earlier Barclays analyses the amount of money poured into the oil market increased significantly this year as investors saw few other options to invest in with realistic chances for a short term positive return. Anecdotal evidence suggests other ways of participating in oil’s stellar price rise, such as through ETFs and CFDs, financial products easier accessible for retail investors have significantly grown in popularity.
The share market isn’t exactly booming at the moment. Neither are bonds, or real estate markets.
What the chart also shows is that when net speculative positions reversed from “long” to “short” in early 2007 the price of crude oil instantly lost its direction, merely trading sideways until speculators again built a net long position in the market (even then the first time seems more like a “mistake” – did the investment community interpret market fundamentals too rosy at the time?). Similarly, now that speculators are no longer significantly “long”, the oil price seems to have lost its previous strong momentum, and appears to be merely looking for direction while oscillating around price levels in the mid-US$130s.
Fund managers and other professional investors exiting the oil market makes perfect sense, even when most technical chartists seem convinced crude oil’s run has further to go, even with securities analysts increasing their price forecasts to around US$115 per barrel for this year, and even with experts at Morgan Stanley and Goldman Sachs suggesting we could be seeing crude oil priced at US$150 per barrel in the weeks ahead.
In order to understand the above I have to take you back to what happened in the gold market last year. Spot gold had entered calendar 2007 on a strong note but remained caught in a trading range between US$600/oz and US$700/oz until September when renewed pressure on the US dollar, caused by the housing slump and the credit crisis in the US, gave gold the opportunity to break loose. Gold went from US$650/oz to US$800/oz in almost one straight line and would ultimately end up above US$1000/oz in January this year.
However, weeks before gold peaked at US$1000/oz, many a professional investor had already exited the market at price levels of US$750 or US$800-something. Why? It was not that they didn’t believe there was no further upside potential left (if they did they have subsequently been proved wrong) but most made a clear risk-reward assessment and concluded that at those elevated price levels, and with the speed at which spot gold was shooting higher, the risks for a swift trend reversal at any time had simply become too large too ignore.
What do you do when you’re sitting on a nice profit and you’re not so sure about when the music will stop and that when it does whether you will be able to secure a chair for yourself? You secure your profit and leave the rest of the higher risk market action to others who are greedier, or who came late to the party and have yet to secure a profit. Once you’ve been around and seen it all, you never mourn about the potential you missed, but you feel content with what you achieved instead.
After peaking at US$1000/oz gold fell swiftly back to US$850/oz and the precious metal has been struggling to find much direction since.
I wouldn’t be surprised if many a professional has made the same assessment during crude oil’s stellar run since March. In fact, that’s what I see when I look at the chart provided by Barclays: professionals who made a big profit on their market positions, but who started to feel less comfortable with what was happening next and who thus made certain their profits were safe.
One oft used expression by oil traders and experts on financial television these days (especially on CNBC) is: “If someone would put a gun to my head and tell me to make a trade, I’d say go ahead: shoot! – because I certainly ain’t making no call on this market”. I read in this a firm confirmation of my assessments above.
Anecdotal evidence, and various other experts, suggest some of the funds that reaped rich rewards in the oil market are again being re-directed towards base metals where aluminium and copper in particular should see further price rises in the weeks, if not months ahead.
Having said all this, there seem to be a lot of experts who are sitting on large amounts of cash at the moment, while having advised their clientele to follow their example. According to a recent survey by Merrill Lynch, a net 42% of fund managers are currently overweight cash (up by 10% from May). Also, the same survey revealed a net 27% of fund managers are underweight equities.
