This post was written by Minyanville contributor Adam Warner:
Smarter minds than yours truly have noted that the oil ETF United States Oil Fund (AMEX: USO) is not the best bullish play on crude here. My understanding of the product is that USO owns futures, and must roll each cycle. And right now oil is in deep contango, which always sounds pornographic but actually just refers to the fact that there's a particularly steep and upward sloped curve in the futures as you go out in time.
I'll take their word for the contango part, but I'm not entirely sure why that necessarily will knock down USO. They'll roll when they roll, and even if the spread is wide, won't it then just depend on what happens in the next month AFTER the roll? I'm thinking out loud here, so if anyone has something enlightening to add on this topic, I am all ears.
I sold and am selling more Nov. puts anyway, so it should not matter a great deal from my standpoint. And I'm not sure I really have a great alternative if I want to do something bullish in oil options.
I don't trade futures or futures options, and as far as pure oil there's Super DoubleUltra Octane Special (AMEX: DBO), which does not have liquid options.
At this juncture, investors/readers thinking about speculating a little in oil via shares in the United States Oil Fund (AMEX: USO) or via an integrated oil company should think again.
With the U.S. stock market meandering and the nation's economic doldrums continuing, the urge can build in investors, particularly those less-experienced, to try something daring.
However, the oil market is currently in a tug-of-war between the geopolitical concern-oriented bulls and the global economy slowdown-oriented bears.
In other words, the oil market is about as balanced -- or as divided -- as it has been in about two years, so says energy trader Jim Dietz. Oil closed Friday up $1.02 to $125.10 per barrel. Oil is down about 15% from its all-time high of $147.27 registered on July 11, 2008, but is still up about 100% over the past year and about 400% since 2000.
Using a proprietary "volume reversal" trading strategy, Mark Leibovit has been consistently ranked among the top newsletter timers. In his VRTrader, he looks at the outlook for stocks, oil, gold & silver -- and offers his choice for exchange-traded funds for traders to play these markets.
Leibovit explains, "The stock market's decline, besides being huge, is relentless. Every rally was met with selling and fresh lows were soon hit. The Dow crashed through the March and January lows and is now trading at its lowest level since September 2006.
"Apparently, that 1500 point rally off the March low was just a giant head fake. The Dow is now down 19% since last October and the S&P is down 18%, approaching bear market territory."
"Breadth is dismal, and down volume is ten times greater than up volume. Sector action is terrible. Seven of the nine market sectors are down more than 2.5%. Ouch! Financials have done it again and have set a new five-year low. Oil spiked through previous records setting a new record high.
"The precious metals also showed strong gains today with gold up 32.80 to 915.10. We cleared the June 9th high of 907.20 touching 909.50 opening up potential to 931.00 (May 21 high).
A finski (a $5 bill) ain't what it used to be - a 10% move at the beginning of last year. Now it's barely 4%.
While I've been bearish on crude through the lens of deflation -- and I continue to believe all roads lead there -- "pure trading eyes" sees the sideways action for the last month.
United States Oil Fund (AMEX: USO) $104-$113 are the parameters to watch (filling of the gaps versus upside breakout). You can drive a truck through that, I know, but I don't make the rules, I just try to play by them.
Hands over eyes, sideways movement under resistance is a bearish churn. The same movement above support is a bullish base.
My current position? Flatter than a sat on hat. And I like it that way... For now.
Editor's Note: In Toddo's honor, this post comes from Ag and Energy specialist Ryan Krueger. Please see more at www.minyanville.com.
In the first six months of 2008, the United States Oil Fund (AMEX: USO) has seen short interest rise 140%, or two times the total float. For its part, the Powershares DB Commodity Index (AMEX: DBC) has watched its short interest climb more than 500% this year. According to Morgan Stanley (NYSE: MS), the average short interest among exchange-traded funds (ETF) in the U.S. is 10%.
I'll alert Minyanville.com readers when Congressional hearings are scheduled to address this other form of speculation, which includes windfall losses.
As for the market, it would seem the largest institutions are equally hopeful -- for the sake of their relative performance -- that this simply can't be: According to some reports I've seen, they're roughly 500 basis points underweight energy.
I'd imagine both will continue to be long shaking heads.
With the soaring oil prices, oil bulls have been benefiting from nice gains lately but there are some pessimistic signs that this may be about to change. The Fed's comments related to inflation stirred some worries among investors that interest rates could be lifted soon. A boost in interest rates will immediately lead to a stronger dollar, and could (and should) result in a sell off in crude.
Talking about this circumstance, SmartMoney is thinking about the best way to protect ourselves against losing money. As a first step, SmartMoney suggests that we reduce commoditiesand increase our allocation in stocks. To back up this idea, the article cites Simeon Hyman, equity strategist of the portfolio advisory group at Lehman Brothers' private investment management unit, who said the company is currently lighter on commodities and "fully invested" in stocks.
David Reilly, director of portfolio strategies at Rydex Investments, is taking into account the possibility of investing in Japan, which "is the most oil-dependent of all major economies. Reilly cites companies such as Toyota Motor (NYSE: TM) and Canon (NYSE: CAJ) which could benefit from investors' attention due to declines in crude oil prices.
In Gold: play the shares, not the metal?, I noted the apparent disconnect between the performance of mining stocks and gold and suggested that the shares may represent a better bet in the near term.
However, there seems to be an even greater disparity in another part of the commodity universe. Over the past 10 months or so, crude oil prices have soared by more than 70%, while energy sector shares have only risen about 5%.
To be sure, there are valid reasons why the stocks might not always track moves in the underlying commodity.
For one thing, the largest energy firms (with the heaviest sector weightings) have fully integrated operations (e.g. they explore for, pump, refine and market petroleum-related products), so a rise in the price of crude oil may not flow directly through to their bottom lines.
Lots of big important news out lately, but I'm not doing anything differently. Nor will I ever. Because I've matured enough over the past decade to sit, wait and strike only when I see all the variables aligned. And that time still is not upon us. By buying The Bear Stearns Companies Inc. (NYSE: BSC), JPMorgan Chase & Co. (NYSE: JPM) may or may not be getting a great deal, but I'm not smart, well-informed or interested enough to really care because there are still too many conflicting variables. I only care for ideal trading opportunities, of which there are none (for my style of trading).
Since January, I've been calling for a 10%+ market drop and warning about a potential disaster not because I'm psychic, but thanks to archaic industry regulations limiting transparency, for industry outsiders, there's really no way how deeply troubled these financial firms are. Judging by Bear's buyout price of $2, even well-informed industry insiders are scared to pay too much to take on such risk.
In sharp contrast to the ten horrifically downtrending stocks I warned against buying in this article, today I feature these 10 solidly uptrending stocks.
It's charts like theirs that make you wonder why you're messing around with any other stocks. Ahhh, if it was only that easy. No matter that all the stocks listed above are making new highs, now the concern is that they may have come too far too fast. In 2008, several of these stocks-the gold plays in particular-have risen nearly 50%. Obviously the oil stocks have also been surging, but how much further can the "black gold" plays really run?
Over the past six months, the S&P energy sector has risen by 8.3%, outpacing the 5.5% fall in the S&P 500 index by a substantial margin.
Of course, the gains in energy-related shares are modest in comparison to the 51% rise in the price of crude over that same span. History suggests, however, that while the two can slip out of sync for a while, they tend to loosely track one another over the longer term
Under the circumstances, the recent sharp slide in the ratio of the energy index to the price of crude oil suggests the shares may be poised for at least a short-term technical bounce relative to the underlying commodity.
One way to play it (depending on risk tolerance): buy the Energy Select Sector SPDR Fund ETF (AMEX: XLE) and sell (or sell short) the United States Oil Fund LP ETF (AMEX: USO).
To understand the United States Oil Fund (AMEX: USO), Ivan Martchev emphasizes the importance of the terms contango and backwardation.
The editor of Vital Resource Investor explains, "A contango is when the price of a commodity for future delivery is higher than the spot price, while backwardation is when the price for future delivery is lower." Here, he explains how the change from one to the other now makes the oil ETF a buy.
"The futures market now suggests that oil isn't as plentiful as it was at the same time last year when the sector began to weaken. For the first time in two-and-a-half years, the oil futures actually suggest that oil's in short supply.
"The market's gone from the notorious contango that made buying and holding the oil exchange traded funds (ETFs) much more painful than the oil stocks, to the current backwardation that looks like a smooth ski slope.
"The current backwardation status favors the buy-and-hold strategy for the oil ETF, the U.S. Oil Fund, which I first recommended as a special situation at the end of March.
The "Heard on the Street" column in The Wall Street Journal recommends oil as a good play in today's market [subscription]. As crude oil supplies should stay tight, the theory goes that oil prices won't be hit along with the stock and bond market, assuming a continued downturn. Oil, like other commodities, should rise if the dollar continues to weaken because it is a dollar-denominated asset. It's highly unlikely that OPEC will raise production for the commodity, even under pressure from the United States and other nations.
These factors are the primary reasons that many traders remain bullish on crude oil despite its recent drop. The quick take: crude oil could potentially serve as a hedge against overall market weakness because it's not nearly as correlated to the stock and bond market as other assets.
How can we play increasing crude oil prices? I came across two commodity price-related ETFs: iPath Crude Oil ETF (NYSE: OIL) and the U.S. Oil Fund ETF (AMEX: USO). As you can see from the chart, these two funds move nearly in lockstep, but I'd argue that the U.S. Oil Fund makes more sense due to its lower expense ratio -- 0.5% vs. 0.75%.
Bloomberg is reporting that two oil "experts" are expecting $100 oil. One expert said $95 crude is "likely this year" and the other said we are "only a headline of significance" away from $100 oil. Interestingly, the article notes that a record number of contracts are outstanding with a bet on $100+ crude oil.
The situation in crude oil predictions makes is rather interesting but I wouldn't take these estimates as being very precise considering the fact that crude oil fundamentals merely fuel speculative buys or sells and the product doesn't really have a true value, because it doesn't generate cash flows.
That being said, I certainly wouldn't bet against crude oil or oil companies. The American people remain reliant on the precious commodity and I don't expect that to change anytime soon, even if alternative energy sources become popular.
Investors who believe that oil prices are going to rally have several options. In this situation I'd much rather purchase individual companies than the commodity simply because oil companies remain very cheap, even on oil prices as low at $50 per barrel. But investors do also have ETF choices such as iPath Crude Oil Total Return Index (NYSE: OIL) or United States Oil Fund (AMEX: USO) for the commodity itself, iShares Oil&Gas Exploration and Production (NYSE: IEO) for Oil&Gas companies, HOLDRS Oil Services Trust (AMEX: OIH) for services companies, or PowerShares Wilder Clean Energy Portfolio (AMEX: PBW) for investors who believe the United States is going to being making significant policy changes to strongly encourage alternative energy choices.
(Note: For ETF information I highly recommend ETF Connect)
While I can't tell you where oil is going or how it's going to move in the next few months, I think it's a pretty safe bet that the demand for crude oil is going to remain and American policymakers are going to be forced to start combating this somehow.
You won't see the contango on Dancing with the Stars; rather its a term used in the futures market to describe the difference in value when the price of a commodity for future deliver is higher than its spot price.
It's also the reason why resource expert Ivan Martchev thinks the US Oil Fund (NYSE: USO) is an excellent short-term trading vehicle but a "terrible" long term investment.
The editor of The Vital Resource Investor explains, "Geopolitical events going on in the Middle East are bullish for oil prices but not necessarily bullish for oil stocks. How come? An attack-driven spike in oil to new highs (proportionately more so the longer the conflict) would likely slow a slowing economy even more."
As a result, he notes, investors should not ncessarily expect to see quick gains in oil stocks if the oil price spikes. He notes, "In conflict-driven spikes that are presumed to be temporary, oil stocks in the past have tended to divorce themselves from the price of oil."
Rather, to play a short-term spike in oil price, the advisor prefers the US Oil exchange-traded fund. As noted at the start of this post, he explains, "USO is a terrible buy-and-hold idea because of the contango in oil futures."
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