The Perfect Storm For Falling Oil Prices

Oil at $130 per barrel!  Wow.  It cost me $90 to fill up today for the first time.  Quite impressive (in a negative way).  Goldman Sachs, who was first to call for the super spike of $100 oil is now saying we’ll be over $200 at some juncture.  A billion people industrializing over the next 20 years.  Oil should be high.  And, it’ll probably be at $200 some day.  But, where is it going over the next weeks and possibly months?  I’ll state the case for why I believe oil may have topped (for now).

  1. Oil at $130 per barrel is having some effect on demand naturally.  We know it’s having an effect in the U.S. and probably some effect overseas as well.  So, you’d have to believe that overall oil demand is falling somewhat.  High oil prices need either high demand and/or low supply. 
  2. Everywhere you read that oil will keep going up for this reason and that reason.  “How can it possibly come down” we hear.  This sort of talk begs for it to fall.  Too many people agreeing it’s going up forever.
  3. Many blame the $130 oil on speculators.  Should oil be at $40, $50, $60?  We don’t know.  But, certainly, speculators have driven the price up to some degree.  This has Americans very angry and it appears the there may be some changes in the futures market.  There are lots of contracts traded over the counter and not regulated by the CFTC (Commodity Future Trading Commission).  The fact that so many are complaining about speculators, etc., you could see oil prices drop if they tinker with the system and reduce some of the speculation.
  4. There are rumors of a lot of oil tankers sitting there in the sea with oil in them.  The reason is because the tankers are delaying delivery trying to capitalize on rising oil prices.  This is known as arbitrage.  So, there is more supply than originally thought. 

For all these reasons, I think oil will fall.  This is as close to a perfect short as there is.  Last week, I bought some of the Ultrashort Oil & Gas ETF (DUG).  This is an ETF that moves two times the opposite of the oil & gas index.  So, essentially, I shorted oil & gas companies, not oil.  So, why did I use DUG to do this trade?  Why not short USO or use futures?  I used DUG quite frankly for two main reasons.  First, because it’s easy and I can use half the money since it’s a double ETF.  Second, because not only do I think oil is going to drop, but also because I think stocks in general will fall.  That’s a double whammy for the oil companies.  So, DUG is the perfect choice.

Remember, we’re in a raging multi-year bull market for oil.  So, we have to be careful not to let oil run away from us if we’re wrong on this trade.  So, tight stops should be used.



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June 2008
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