The heating oil market has developed a textbook pattern for trend following continuation lower. This week, we'll look at how these long-term, macro-economic trends play out through the eyes of the commercial traders in the Commodity Futures Trading Commission's weekly Commitment of Traders report. We're going to examine the cycles of accumulation and distribution among the market's participants as well as where we are in the current cycle. Finally, we'll end with a shorter time frame chart that details the actual commitment of trader's buy and sell signals over the past year in the heating oil futures as we begin to develop our energy outlook for 2016.
We often talk about the commercial traders as being value traders and that their hedging activity provides the buying and selling pressure that creates a market's natural meanderings. While this is true, we'll develop it in detail later on. The commercial traders can also provide a strong indicator of major advances and declines. There are two components to this. First is the market's trend. When commercial traders push their buying or selling to new recent maximum levels, they're telegraphing their notion of value. The primary emphasis in the chart below is that, while the range of the commercial net position varies by more than 100,000 contracts over the last 15 years, the market usually responds in kind when their actions reach new recent maximum levels. We've outlined the typical pattern in the chart below. The blue resistance lines mark the recent high for the net commercial position. The ellipses mark a new net commercial trader position high above the recent highs along with the corresponding market action, in this case major bottoms.
The second point to make in the long-term heating oil futures look shows up on the right side of the chart. Note especially, that when a market is in decline, as heating oil currently is, the commercial traders' purchases only bring the underlying market back to mid-range. This is the inverse of the bullish pattern. Remember, commercial traders are bargain hunters. Long hedgers are looking to lock in prices under their current cost at the refinery. Meanwhile, heating oil refiners are looking for any opportunity to sell at the prices they could've gotten had they sold yesterday, last week, month or year. The commercial trader net position now shifts to bearish mode as the refiners find themselves on the defensive and the end users have the upper hand in price discovery. You'll see this clearly in the, "Commercial Trader Momentum" panel of the second chart.
Currently, commercial long hedgers have met their recent needs going forward as they've bought into the new lows. Based on the given fundamental outlook, there is little reason to expect them to make new net long highs above the recent maximum positions held. Therefore, there is a much higher likelihood that as the market bounces or consolidates, some of the hedges will be lifted. Based on recent commercial trader behavior, we believe this to be around 50,000 contracts based on their recent capacity. We expect this market to fail once again as it stabilizes and begins nearing its long-tern downward trend line.
Moving to a shorter term chart over the last year shows how the value area interacts with the long-term trend and the commercial traders' behavior. The changing max values of the commercial traders determines how collectively bullish or bearish they are both at the market's current price level and their expectations of future prices. Meanwhile, their moves within their recent ranges usually indicate turning points within the market's current pricing structure. These are defined by the value areas. The chart below shows the last year's worth of movement which includes the continuation of the market's downward trend as well as the trading opportunities presented during January through July's sideways consolidation.
- The COT buy and sell signals plotted over the last year show their value in a range bound market as well as how to use them as a trigger for entering inline with an existing major trend.
Finally, let's examine the bottoming process, swing trading and the resumption of the major, downward trend over the last year. Commercial traders set a new net long record last December. We saw this at least stalling the downward slide in energy prices and published, "Momentary Crude Oil bottom Formed," accordingly. Our second attempt, "Picking a bottom in Natural Gas," was more successfully timed on January 15th. Meanwhile, we shifted sides along with the commercial traders as the market rallied towards its trend and the commercial traders continued to sell in, "Crude Oil Spike is a Selling Opportunity." The point of listing these three articles is that they all employ the same strategy which shows commercial trader buying at undervalued prices and commercial trader selling at overvalued prices. We track their value areas, recent maximum net short and net long positions as well as a given market's position within its overall trend to determine and produce the Cot Signals.
This brings us to the current situation and outlook for the heating oil market. Heating oil prices have made new lows, once again and the trend remains lower. Recent long hedger buying is sure to dry up as they've met their forward needs at significantly discounted prices. Therefore, we expect these same users to lighten their positions as the market stabilizes, bounces or consolidates. However, once this market again nears its trend, we expect another violent low to be made. Perhaps, under $1.20. This would give the market room to bounce around while providing swing trading opportunities through the spring. By then, we'll know what effect production cuts have had as compared to an American public choosing to vacation increasingly domestically by automobile as worries remain high and petroleum remains cheap.
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