Data Brief - Why I'm Not Filling My Tank Now

Why I'm Not Filling My Tank Now

Saturday, April 26, 2008

I grew up in rural northwestern Wisconsin, one of those towns with no stoplights and just a handful of stop signs. The only establishments with regular customers were bars, churches, taxidermists and gas stations...and there were about equal numbers of each.

At home recently, I was struck by how much the price of gasoline was a topic of conversation. Not just the usual government conspiracy talk (always a popular subject in rural towns), but the fact that many folks were seriously altering their behavior. No more 25-mile trips to the nearest Wal-Mart, no more leisurely afternoon nature drives, and fewer trips to the "big city" to see the grandchildren.

That's certainly not an incisive insight - high gas prices have been one of the lead news stories for months, yet it keeps climbing higher. There are a few factors coming together now, though, that suggests maybe those rural towns will get a bit of a breather in the coming months - the "smart money" is betting on a decline in gas prices, the "dumb money" is as bullish as ever, and seasonality is waning.

Let's look at an example of all three. First, the smart money.

I have some issues with the Commitment of Traders reports for some commodities, as I think they have become less representative of trader positions than they used to be before the popularity of off-exchange derivatives transactions. Still, they're something I check regularly, and they've been fairly useful for watching Gasoline.

In 2007, the Unleaded Gasoline futures contract changed to a Blendstock Gasoline contract, which causes some issues with historical comparisons. Still, it wasn't that big of a change and trader positionings weren't impacted much at all.

In these reports, the definition of a "commercial hedger" is a large trader who uses the futures markets to hedge their day-to-day business risk. These are very large firms that have an intimate knowledge of their markets, which is why they are considered the smart money. They are typically net short the contracts in their market, and vary the size of that position based in part on their view of future price risk.

The chart below shows hedger positions for Gasoline futures. The green arrow highlights their current position, which is net short 75,000 contracts. That is an increase of 10,000 contracts from last week, and is by far a new all-time extreme.

In the past when hedgers had more than 50,000 contracts net short (the red dotted line on the chart), Gas tended to back off, at least temporarily. It's not a perfect indicator by any means, but it's one factor suggesting that the big boys are betting against another sustained run higher in Gas prices.

Now let's take a look at the other side of the coin - the public in general. The Public Opinion charts that we post to the site are a proprietary mix of many other sentiment surveys, weighted by the historical accuracy of those surveys.

Currently, the Public Opinion is 84% bullish, the highest amount since August 2005. Gas has entered a danger zone in the past when the Public Opinion has reached 80% or more, so we're well into caution territory here.

Since the early 1990's, whenever Public Opinion has been this high, one month later Gasoline was higher 42% of the time, and showed an average return of -1%. By two months later, it was up only 5% of the time and sported an average return of -10%.

This can be an exceptionally volatile commodity, though, and even given those solid negative two-month returns, in those two-month periods the contract averaged a maximum gain of +14.8% and a maximum loss of -16.2%. That means that sometime during the two months, we saw wild swings in both directions before it ultimately ended lower a couple of months later. After two months, the returns begin to revert to more in line with random.

The two-month respites in gas prices were typically pretty good for stocks - the S&P 500 was higher 79% of the time by an average of +3.2%. The U.S. Dollar was positive 89% of the time with an average return of +1.3%, and Crude Oil was down 100% of the time with an average return of -11% (likely due in part to a higher Dollar during most of those instances).

Another factor entering the picture here is seasonality. While seasonality provides a dubious edge in stocks, in commodities is is often more reliable due to the relatively consistent fundamentals of those markets.

Below is the seasonality chart we show on the site for Gas:

We can see that Gas just experienced its sweet spot of February through April. Now it's entering a much more dicey period from May through November. Other than July and August, the contract tends to swoon during the summer/fall months.

Let's take a little different view on seasonality. Let's look at the months when the contract tends to hit new 52-week highs:

Out of the 208 days that Gas hit a new 52-week high, 22% of them came during April. Only 8% came during May and 3% during June. There was a flurry of highs between July and August, but then it tapered off again into the end of the year.

So it looks like we currently have the "smart money" betting on a decline in Gas prices in the coming months, the "dumb money" betting on a rally, and seasonality working against the commodity.

Taken together, that seems like a recipe for lower - but possibly volatile - prices heading into the summer. Of course, this doesn't take into account fundamental supply and demand factors, which will trump technicals like this on a longer-term basis, but for now I've backed off on filling the tank on our cars, betting that I'll get lower prices the longer I wait.