Oil & Energy Stocks Signal Caution

Energy has been big winner in recent months. This includes Oil (NYSE:USO) and energy related shares. While I hate the expression “crowded trade,” it is hard to argue otherwise after consulting some sentiment data.

Let’s start with Oil (NYSE:USO) and the commitment of traders report. Note that from 2002-2010 commercial traders cumulative position ranged from short 100K contracts to long 100K contracts. In early 2010 their net short position dipped below 100K contracts before moving closer to neutral around mid-year. Since then, speculators (non-commercials) have gone furiously long the market as the commercial net position has surged to over 300K contracts. I looked at historical charts and this position is a record.

Not only the professional speculators who are long energy so too are the retail players. Our evidence is the Rydex data and chart from sentimentrader.com. This shows fund flows in Rydex’ Energy Fund. The middle column shows assets in the fund and the bottom column shows assets in the fund relative to all other sectors. Needless to say, these metrics have exploded in the last six months.


Keep in mind that sentiment follows the trend. More and more bulls means higher prices. Yet, when there are too many bulls around or too much money going into a market, it poses a short-term risk and creates an environment that is ripe for profit taking. One reason we like energy is because it often peaks after the stock market. For example, if the market peaks in April or May then energy could peak in August or October.

That being said, it is time to be cautious on energy in the near-term. We know little about geopolitics but we do know that there is record speculation in the Oil market and that will end at some point. Does it end at $120 Oil or $90 Oil? We don’t know but we do know that there is huge risk in the market with a record speculative long position. Meanwhile, tons of retail players have already piled into the shares and could move out on any sudden change in the situation in the MidEast.

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Good Luck!

Jordan Roy-Byrne, CMT