Skip to main content

Short The Bugger At US$139 For Year End Delivery

US$139. Asset prices don’t rise indefinitely — but oil is surely testing that hypothesis. US$139, thats the second short squeeze in a couple of weeks. That, to me, is a sure sign of over-speculation on the long side. Thus, it makes brilliant mid term trading to take a 6 month dated put option on oil at US$139. The interplay suggests a peaking of buying frenzy. Just imagine the number of long positions taken up over the last few weeks. Now imagine who will be taking over these positions when these long players take their profits. A brief pullback to around US$122 a barrel early in the week fooled a few investors into thinking perhaps oil’s peak had passed.

But oil exploded on Thursday and Friday, gaining a ridiculous 13% on the New York Mercantile Exchange in two days to trade at US$137.08. Every bubble in history had a good story.

According to the IEA: Economic slowdown and high oil prices have continued to depress demand - global consumption forecast cut again by about 400,000 b/d from April report, bringing total cut to 1.2m since December to 86.8 mb/d. This is still up from the average level of 86 mb/d recorded in 2007. April global oil supply fell to 86.8 mb/d from 87.3 mb/d in March, led by lower supplies from OPEC, North Sea and non-OPEC Africa. 2008 non-OPEC supply projected to reach 50.6 mb/d. Non-OPEC output growth in 2008 is now seen averaging 680 kb/d, compared with 550 kb/d in 2007.

Oil demand fell in the first quarter, which supports the idea that prices should drop. On the other hand, the trade is being dominated by investment flows.

According to OPEC: Recent high volatility in oil prices due to short-lived, non-fundamental factors. Although fundamental factors such as cold weather and refinery difficulties have had some impact, prices have mainly been driven by non-fundamentals, in particular financial market turmoil, US dollar depreciation, and worsening US economic outlook. Moreover, the influx of financial investments into commodities has helped to repeatedly push crude oil prices higher, amid occasional periods of profit-taking.

The biggest culprits are the long-only commodity index funds and ETFs. They simply buy baskets of commodities at whatever the price is, speculating on the rise in the price of the overall commodity market. It is a one-way trade. But there are limits to how much exposure speculators can buy, because the CFTC will allow a speculator to only buy so much of any given market, to keep large players from getting a corner on the market and driving up prices, a la the Hunt brothers and silver in 1980. These limits are known as "position limits."

There are no position limits for commercials who are hedging. They are in theory hedging their physical exposure to a given commodity they are selling or buying. The CFTC created a loophole when they allowed investment banks to be classified as commercial investors. So, when a long-only commodity index fund wants to buy a million barrels of oil, they can go to the investment bank, who will sell them a "swap" on the price of oil, and then immediately hedge their exposure in the futures market.

To be sure, the long-only index fund can now create positions far in excess of the position limits that are enforced upon normal speculators. These funds can grow to be huge - multi-tens of billions of dollars. Even though they are speculators, they are not included in the data as speculators. Because they get their exposure from an investment bank, they are ultimately listed as a commercial. In total, they represent an enormous part of the commodities markets. But they are providing liquidity, so what's the problem? They are not actually hoarding the commodities. The price is still set at the spot price. From the rumblings in Washington and I am sure among many big central bankers, I would bet on some "new rules" to be introduced very very soon to limit these so-called commercials from having "excessive position limits" - these so called long positions matched by swaps can easily be curtailed by new "rulings". Because seriously, even I have to agree with AAB that he is probably right that speculators have driven up oil price to pretty excessive levels. Forcing many countries to abandon subsidy on oil is a clear sign that central bankers are almost at the end of their patience with the "free markets".

How much speculation? According to the Dept of Energy, annual Chinese demand for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion barrels, an increase of 920 million barrels. Over the same five-year period, Index Speculators demand for petroleum futures has increased by 848 million barrels. The increase in demand from Index Speculators is almost equal to the increase in demand from China!

You can see from the media frenzy that all seem to be focused on supply constraints only. None appears to be giving much weight to the demand destruction given the explosion in oil price. Economies are being rein in, the US looks like edging towards higher unemployment and their oil consumption habits have changed dramatically owing to the last few hikes in price of fuel, oil subsidies in emerging economies have be slashed which should curtail demand substantially - all these demand destruction seems to mean nothing to the speculators.

Hence my SHORT call is based on: quick successions of two major short squeeze; rampant open long interest and subsequent rollovers plus momentum players in this bubble run; players ignoring the fact that many countries have reduced their subsidy on oil which pulls back substantial demand for oil and changes consumption patterns dramatically; higher inflationary rates globally as economies try to rein in their economies by raising interest rates; overall demand destruction owing to price explosion; and finally look for legislative rulings and "new regulations" which would severely curtail some of these "commercials" in curtailing their inexhaustible "position limits". Watch your steps on falling bodies when the profit takers stampede out of their long positions.

The good news from all this is that its looking very much like a bubble now for the price of oil, and a correction will be pretty good and severe. If the price of oil falls back to a more manageable US$105, the impact will be very good for global equities. So just get ready.

p/s photos: Tangmo Pattarathida


Bryan said…
Thank you Dali. I think besides crude oil, speculators in Malaysia also interested in FCPO. Could you please post something about FCPO as well.
Opine said…
Have to respectfully disagree due to :-

- US trying to inflate their way out of debt, more cash means lower value for USD, equals higher oil prices
- External factor premiums, mainly wars (Iran?) and hurricane season.
- Possible capping of oil exports from saudi, despite their talk of over speculation.
-Big houses speculating on the uptrend to recover losses in other sectors( subprime, Alt-A, CDS.. et al)
-Lack of viable source for alternative energy or even a blueprint to address the overall demand

My prediction oil above USD 150 year end.

Just my 2 cents.
bl said…
"Thus, it makes brilliant mid term trading to take a 6 month dated put option on oil at US$139."

Kindly advise which internet platform to trade this & what symbols ? So when the day about to come ,i am ready.
Salvatore_Dali said…

there are many ways to trade that ... i guess u must be a savvy investor n have traded on the chicago merc, then u get a t\full array of options and futures ... failing that, just open up any dailt FT newspapers, they have tons of websites which trades and makes bets on all sorts of commodities and currencies... stick to proven established names, one has even just opened an office in KL... but I cannot be doing the mktg for them... plus its leveraged instruments, hence I would not want to advise my readers to just go in head first ...
Salvatore_Dali said…
to get a better perspective and advice on how to play oil futures n options or where to play them, go to Boon's blog at Trade Bursa Malaysia
Opine said…
CNBC : Uri Dadush from the World Bank Expects oil will come down to around USD95 by year end.

In the meantime oil is up 3.05 to 137.40.

Time for the authorities to do something instead of talk if that prediction by the World Bank is to come true.

Popular posts from this blog

My Master, A National Treasure

REPOST:  Its been more than two years since I posted on my sifu. This is probably the most significant posting I had done thus far that does not involve business or politics. My circle of close friends and business colleagues have benefited significantly from his treatment.

My Master, Dr. Law Chin Han (from my iPhone)

Where shall I start? OK, just based on real life experiences of those who are close to me. The entire Tong family (Bukit Kiara Properties) absolutely swear that he is the master of masters when it comes to acupuncture (and dentistry as well). To me, you can probably find many great dentists, but to find a real Master in acupuncture, thats a whole different ballgame.

I am not big aficionado of Chinese medicine or acupuncture initially. I guess you have to go through the whole shebang to appreciate the real life changing effects from a master.

My business partner and very close friend went to him after 15 years of persistent gout problem, he will get his heavy attacks at least…

PUC - An Assessment

PUC has tried to reinvent itself following the untimely passing of its founder last year. His younger brother, who was highly successful in his own right, was running Pictureworks in a number of countries in Asia.

The Shares Price Rise & Possible Catalysts

Share price has broken its all time high comfortably. The rise has been steady and not at all volatile, accompanied by steady volume, which would indicate longer term investors and some funds already accumulating nd not selling back to the market.

Potential Catalyst #1

The just launched Presto app. Tried it and went to the briefing. Its a game changer for PUC for sure. They have already indicated that the e-wallet will be launched only in 1Q2018. Now what is Presto, why Presto. Its very much like Lazada or eBay or Alibaba. Lazada is a platform for retailers to sell, full stop. eBay is more for the personal one man operations. Alibaba is more for wholesalers and distributors.

Presto links retailers/f&b/services originators with en…

How Long Will The Bull Lasts For Malaysia

Are we in a bull run? Of course we are. Not to labour the point but I highlighted the start of the bull run back in January this year... and got a lot of naysayers but never mind:

p/s: needless to say, this is Jing Tian ... beautiful face and a certain kind of freshness in her looks and acting career thus far

I would like to extend my prediction that the bull run for Bursa stocks should continue to run well till the end of the year. What we are seeing for the past 3 weeks was a general lull where volume suddenly shrunk but the general trend is still intact. My reasons for saying so:

a) the overall equity markets globally will be supported by a benign recovery complemented by a timid approach to raising rates by most central banks

b) thanks to a drastic bear run for most commodities, and to a lesser extent some oil & gas players, the undertone for "cost of materials" have been weak and has pr…