Oil Bulls Go All-In as XLE Topples Key Trendlines

CoT large speculators are holding near an extreme net long position on crude futures

by Bernie Schaeffer

Published on Apr 17, 2018 at 9:01 AM

Oil futures and energy stocks stormed to the forefront last week, as escalating tensions over Syria sparked supply concerns. This high-stakes geopolitical catalyst prompted a fairly significant breakout for the recently slumbering Energy Select Sector SPDR Fund (NYSEARCA: XLE) -- which gapped above its 50-day moving average last Tuesday, April 10, to snap a two-month slump below this short-term trendline. XLE then continued on its tear in the following session by taking out both its 80-day moving average and the $70 level (a psychologically significant round number that marked the Feb. 27 intraday high, and also represents a 50% retracement of XLE's rally from its Aug. 21 closing low to its Jan. 22 closing high).

Simultaneously with XLE's sudden jolt higher on the charts, call activity on the exchange-traded fund (ETF) ramped higher -- and in fact, as of last Thursday, April 12, total call open interest on XLE surpassed put open interest for the first time in over two years, with the last such "inversion" of the fund's put-tilted "open interest norm" occurring as far back as March 2016.

Among short-term options, it was the fund's May 75 and May 73 calls that garnered much of the attention last week. The overhead May 73 call accumulated nearly 9,900 new contracts after the volume from that single April 10 "breakout" session translated into open interest, while heavy buy-to-open volume occurred at the XLE May 75 strike last Wednesday.

Technically speaking, XLE hasn't traded above $73 since Feb. 2 -- in a tidy coincidence, the same day the weekly Commitments of Traders (CoT) report showed large speculators on crude futures at a new net long extreme (and current reigning high) of 784,290 contracts. Since that early February bullish extreme among this group of investors (whom we've found, more often than not, to be fairly reliable contrarian indicators), the net long position on oil has receded slightly, but continued to hover near its highs. As of this last Friday's report, large speculators have pared their record net long position on crude by only about 5%.

Meanwhile, etf.com data shows net inflows in the neighborhood of $23.84 million for XLE on a month-to-date basis, with two days topping $115 million in inflows -- Wednesday, April 4, and Wednesday, April 11 (the latter of which, as alluded to earlier, is the same day XLE closed above its 80-day moving average). That amount compares to total net outflows of $25.58 million for the full month of March.

And while we're on the topic of XLE extremes, we would be remiss not to point out that, following a 17.68% decline in the reporting period ended April 1, short interest on the energy fund is now at its lowest point -- just 18.49 million shares -- since September 2009.

The combination of unusually high call open interest relative to put open interest, fairly robust inflows, extremely low short interest, and a sustained net-long extreme in crude futures would seem to indicate -- without making too many leaps in critical thinking -- that oil enthusiasts are out in force right now, with bullish bets blazing. And these speculators would no doubt be pleased to learn that data from Schaeffer's Quantitative Analyst Chris Prybal points to yet another XLE extreme that could be in the process of playing out. Namely, since inception, the fund has delivered its biggest average monthly return of the year -- a gain of 3.4% -- during April.

Setting that positive seasonality aside (which seems prudent enough at the moment, given a fundamental backdrop driven, to a non-trivial extent, by rapid-fire Trump tweets), we'd issue a word of caution on buying the rally in XLE right here and now, as the fund has yet to "prove its mettle" by reclaiming a foothold above its year-to-date breakeven level at $72.26. Potential support here was previously tested back on that memorable day of Feb. 2 before promptly being broken in the next session, and -- with so many oil bulls already "all in" on this fledgling leg higher -- XLE may struggle to drum up the additional buying pressure necessary to make its way back into the black for 2018.

xle 50-day 80-day moving averages

Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, April 15.

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