Smart Money Betting Against Energy – Asbury Research

As WTI crude went above $50 last year, Kosar noticed that the Commitments of Traders (COT) data was showing a record net-short position among smart money hedgers in the crude oil futures market. Now that crude is in excess of $60 a barrel, these hedgers have dug in and increased their short position even more, Kosar noted. Thus, we have a large ‘smart money’ net-short position that’s losing money. “Here’s why that bothers me,” he said. “I don’t like to fade the smart money, but when oil prices got up to $120 a barrel years ago, the same thing happened. At about $60 or $70 a barrel, these hedgers were really short, and the market kept going up.” At that level, hedgers had to start buying back their short hedges. This short covering forced buying, which is a big part of what fueled oil’s move to $120. Normally, Kosar prefers to avoid splashy calls, but when he sees a group or entity this leaning this heavily to one side, it bears mention. “That’s an outlier,” he said. “That’s not something I would bet on, but it is something I’m watching now because these smart money hedgers are under the gun right now. Every time oil goes up a dollar, these guys are feeling more pain.”

Oil, Bonds, and Commodities

As we have oil prices heading higher, we can expect an inflationary impact. The question becomes, will this influence the Fed’s rate increasing cycle, and what can we expect from bonds? Just as with oil, hedgers in the futures market hold an extremely large net-short position in the 30-year T-bond, Kosar noted. They’re betting big that long-dated Treasury prices are headed downward, with long-term U.S. Treasury yields and long-term interest rates headed up. We’re also starting to see strength overall in commodity prices. Kosar was in and out of the metals and mining ETF several times over the past 12 months, and we’ve seen a recent explosive rise in base metals. “Aside from what I mentioned in oil and rates, we’re starting to see some of the building materials … starting to do better,” he said. “You put all of those three together, and it suggests global growth and more global economic strength into the early to middle part of this year. Yes, the market’s over-extended, but if we look across the landscape, what I’m seeing is still positive.”

Investing in the Unknown

There are uncertainties here, and Kosar recommends using a focused approach, especially for those who haven’t participated in the bull market so far. Instead of buying the S&P 500, he recommends identifying individual stocks that are likely to outperform, or industry groups that will. By focusing on these industry group ETFs and individual stocks, investors can keep their risk-to-reward ratio down to a low level. Eventually, the market is going to top out and we’re going to get a 20 percent correction, Kosar noted, so staying focused will allow investors to continue in the market and limit risk. While homebuilders were his group of choice to find outperformance last year, he’s looking for opportunities in the healthcare sector this year. “I don’t [put on a trade] unless the initial risk is 5 percent or less, and the reward is 1-to-3 or, in other words, I’m risking $1 to make $3,” he said. “What I would suggest is, if you missed this and you can’t stand it anymore, use a rifle approach, rather than a shotgun approach.” Source: Asbury Research