22-May-08
$135 oil? You ain't seen nothing yet.
I can clearly remember where I was when oil hit $40 for the first time. I was in college and interning for Merrill Lynch, fascinated at the rise of the commodity. I was convinced that it would seriously jeopardize US growth prospects. I was in the breakroom, watching CNBC, and staring at the Statue of Liberty. I had been growing more and more bearish of equities, not realizing the benefit of having a contrarian view of things.
Now, oil is more than 3 times that level and we still have yet to have a quarter of negative GDP growth and we may not for the remainder of 2008 (fortunately, regression analysis shows a six quarter lag of oil price and GDP growth correlation).
I won't speculate on where oil is going. But I must comment on some strange "goings-ons" in the market. I am becoming aware of the hints of the market being cornered. Hardly a month ago, oil was (appropriately, in my opinion) trading in backwardation of about $12 from spot out to 2016 (meaning you could get delivery in 8 years at a price $12 cheaper than the current price). Who could have possibly thought that the market prices wouldn't correct themselves and over time, the price would drop. It made sense. But today, that same 2016 contract has shot up nearly 50%. Oil is again in contango and 2016 oil eclipsed $140 yesterday and is over $142 today.
Oil at such a large contango is not necessarily reason to worry. One can argue that the it is simply mispriced. However, given the sharp deviation from the norm, I would expect that volume would intensify and traders and speculators would be all over the 2016 contract, trying to make a few bucks. However, volume was pitiful (it was especially low before the media got a hold of the action). It hints, and again, only a hint, that some fund is gobbling up every last bit of long-dated oil and is refusing to sell. This is dangerous. It could result in volatility and prices that we have not seen before. The market is still far smaller than global equity markets. While this isn't the 1980's when the Hunt brothers attempting to corner the silver market, we are still facing a problem. If in two months oil is at $300 or $30, I won't be too surprised.
FWIW, I'm not trading against this conspiracy theory. The market's failure at the 200 day MA has turned me less bullish. As I look more and more into the material and energy names, my only wish is that I'm not buying at the top. With bullish sentiment far from extremes, my guess is the upwards trend will continue.
Posted at 07:28 in Market Report | Permalink | Comments () | Top
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