Rotating Bull Returns
Much to the delight of the bulls the S&P 500 Index made new closing highs four out of five days last week establishing a new upward sloping trendline from the November 4 low shown below. Most all indicators confirm the bullish view and perhaps even the energy sector may be in the process of turning higher as explained along with a WTI crude oil update from the Commitment of Traders report
S&P 500 Index (SPX) 2500.23 gained 38.80 points or +1.58% for the week making new closing highs every day except Thursday while redrawing the operative upward sloping trendline, USTL from the November 4 low at 2,083.79. For those preferring specific sectors, now the challenge is to keep up with rapid rotation out of the leaders into the laggards.
Chart Courtesy of StockCharts.com
CBOE Volatility Index® (VIX) 10.17 slid -1.95 points or -16.09% for the week while the comparable IVolatility Implied Volatility Index mean, IVXM declined 2.07 points or -24.27%.
VIX Futures Premium
The chart below shows as our calculation of Larry McMillan’s day-weighted average between the first and second-month futures contracts.:
With 2 trading days until the September expiration, the day-weighted premium between September and October allocated 8 % to September and 92% to October for a 25.72% premium right in the green zone, not too hot, nor too cold.
The premium measures the amount that futures currently trade above or below the cash VIX, (contango or backwardation) until front month future converges with the VIX at expiration.
Market Breadth as measured by our preferred gauge, the NYSE ratio adjusted Summation Index that factors out the number of issues traded, and reported by McClellan Financial Publications, continued higher since our last look in Digest Issue 34 "Pull Back Ending [Charts]" adding 363.43 points with 188.79 points this week, closing at 535.85 and back above the 50-day moving average in blue confirming the bullish view.
Crude Oil Update
WTI Light Sweet Crude Oil (CL) 49.58 basis September futures down .13 points or +.26% for the week, after exceeding resistance at the downward sloping trendline, DSTL considerably above the 50-day moving average (red line below).
Further, with a little imagination, there might even be a developing Head & Shoulders bottom pattern.
Chart provided by Barchart.com
From the Disaggregated Commitments of Traders - Options and Futures Combined report as of September 12 "Managed Money," the group that best correlates with crude oil price changes and arguably the most important, reduced their long position -17,079 contracts while reducing their shorts +4,986 for a net position decrease of -12,094 contracts representing 5.17 % open interest down slightly from 5.59% on September 5.
157,891 contracts net long representing 5.17% of the open interest vs. 5.59% week ending September 5.
Here are they are shown by a change in numbers of contracts.
Producer/Merchant/Processor/User, (Commercials ) or "PMP" +24,861
Swap Dealers, or "Swaps" -21,505
Money Manager, or "Managed Money" -12,094
Other Reportables, or "Others" +9,553
Nonreportable Positions (Small Speculators ) -815
Typically Producer/Merchant/Processor/User, (Commercials ) or "PMP" are net short contracts as producers hedge production by selling futures contracts and then delivering crude against their shorts at expiration or if the price declined, buying back short contracts for a gain and buying cash crude for delivery. However, since processors and users are also included in this category their buying partially offsets producer selling resulting in a net short position.
As a percentage of open interest, the chart below shows a declining net short position for "PMP" since peaking at 12.03% on April 19, 2016, when cash crude was 40.91.
3.24% vs. 4.08% week ending September 5 and the lowest since December 9, 2014 at 2.73% when they were net short 62,444 contracts while cash WTI was 63.75 and declining. This week they were 99,058 net short contracts with cash WTI at 48.22.
Either way, producers are unwilling to sell production forward at current prices or they have already hedged all available production while demand from processors and users continue to rise as they hedge against future price increases. There is some evidence for this interpretation since "PMP" added 45,271 long contracts while increasing their short position -20,410 for at net position change of +24,861 contracts.
Adding Brent crude oil to the equation further, supports the increasing demand or perhaps declining global inventory scenario as the Brent premium over WTI began increasing on August 18 from the 2-3 range to 4.21. On September 15 the premium had increased to 5.41. On September 12 Reuters reported the volume of crude oil stored offshore in the North Sea declined in the last month, consistent with Brent futures moving into backwardation when the front-month contracts trade at a premium to the deferred contracts making storage trades uneconomical, a condition associated with a tightening market.
The chart below shows the Brent premium advancing on August 18 at the vertical orange line with Brent shown as the black price line.
Chart Courtesy of StockCharts.com
In addition to increasing demand and declining inventory, stockpiling to hedge geopolitical risk could also be a part of the answer. Further, since September is typically one of the seasonally weaker months, current Brent and WTI strength suggests prices are firming and likely to continue advancing.
While geopolitical risk remains a concern advances last week by the major indexes and confirmed by most indicators, suggests absent some unexpected event, equities should continue higher. If crude oil prices continue increasing as suggested above, the lagging large capitalization oil and gas companies in the major indexes will add additional upside. There was one sign of increased hedging activity by large money managers taking advantage of lower options implied volatility as S&P 500 Index put open interest increased as SPX reached new highs.
Summary
The S&P 500 Index recovered from geopolitical news two weeks ago and then failed to react to a similar provocation last week making four new closing highs on increased sector rotation. In the event, crude oil prices continue higher the major indexes will be further supported by advancing large capitalization oil and gas companies in the energy sector.
Disclaimer: IVolatility.com is not a registered investment adviser and does not offer personalized advice specific to the needs and risk profiles of its readers.Nothing contained in this letter ...
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