September 02, 2003

The Futures Market and Cash Indexes, Making it Work

For awhile now I've been saying this is a trader's market. I say that because most stocks aren't trading at good values. If you're going to be in the market, your main strategy is to find what the big themes are and then pick the exchange traded funds, holders, and iShares (I call them all Precision Guided Investments, or PGIs) that are leveraged to gain or lose if you're right about the them. And I'm finding out now that using the spread between the futures prices and cash index prices can help. Let's take oil. Crude oil futures were down this morning in London by $.175 to $27.50 per barrel. This alone didn't guarantee that oil stocks and the big oil indexes OIH, XOI, OIX, would be down. But it was a pretty good sign. Just as a large spread between the S&P futures and the S&P cash index triggers program buying when one index gets too far ahead of the other, it's conceivable that a similar dynamic takes place in the commodities markets...where you have cash indexes and futures indexes for most commodities...or in the interest rate market...or in the bond market. In fact, it's possible that there's a whole universe of correlations...whereby the futures prices tell you something about what the market might be doing on any given day. Of course, you'd have to expect that the real world to intrude on the theory. Again, let's take oil. The end of the summer driving season typically sees lower gas prices. But the wild card right now is Iraq. What is the stronger influence on oil prices right now: Iraq, or seasonal oil consumption patterns? And how do low natural gas and heating oil stocks heading into the winter complicate matters, and affect prices? And how efficient can the market possibly be at factoring these unknowns into prices? The futures market, which is trying to figure out what things will be worth, is inherently more speculative than the cash market (I know, I know, it's all speculative right now.) And to the extent the asset being traded is influenced by outside factors, the futures market and the cash index might tell you very different, even conflicting things. As it is, the CBOE oil index (OIX) is up 0.39% on the day. The Amex oil index (XOI) is up 0.37%. And the oil service holders (OIH) are down 1.17%. The markets is a mystery sometimes. It has a language. But sometimes in speaks with a forked tongue. I'm going to start watching the futures vs. the cash indexes and see if I can turn it into a meaningful indicator of what a) happened, or b) might happened. I'll keep you posted.


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