Wednesday, May 28, 2008

Are You Shorting Crude Oil Today?

Just a little more than a month ago I wrote here about a trading phenomenon called the "climax run." One of the points I was trying to make was that crude oil prices are in a climax run (AKA- "a bubble") just as certainly as housing was a few years back and tech stocks were in 1998-March 2000. The chart above from Thomson (h/t Carpe Diem) depicts this run on oil pretty clearly. Most of the media, including the business media, has been projecting $200/bbl crude and $10+/ gallon gasoline right up to this very morning as if higher prices don't change consumer behavior. Markets don't work that way. They correct. And when they correct after climax runs they usually go down hard.
So why do I bring this up today? Well, in that April post I discussed whether the $120/ bbl price at that time was a top. Of course, my answer was, "who knows?" but I did say it could easily run to $140. Last Thursday (5/22) crude hit $135.09. In little more than two trading days since it's dropped over 6%. When it passed down through $130 lots of selling programs were triggered. Trading curbs? We don't need no stinkin' trading curbs! A great example of how this can work is shown by recent wheat trading. Most people, if asked, would probably say that wheat is going up, up, up in price right now. Wheat certainly was going up in its own climax run but, over the past three months, the price of wheat has plunged over 40%. If crude oil did that we'd have $80 oil by Labor Day. In fact, there may be nothing to stop it from doing just that.
Why is this happening now and will it continue? First off, this 6% drop could just be a head fake and oil could still climb further. But, for the moment, let's look at why it's dropping. First and foremost, the dollar has strengthened against other currencies. It's been my contention (with apologies to the great T. Boone Pickens who says it's only about supply/demand tension) that the run up in commodities has been largely due to the weak dollar. Basically, rather than shorting the dollar a trader can achieve the same thing by going long on commodities. The weak dollar is a sign there are too many dollars, otherwise known as inflation. Secondly, US demand is dropping. That's right, you may not have heard about this on the TV or in the newspaper, but demand for gasoline in the US is falling:
--- March 2008... miles driven in US was 11 BILLION miles fewer than March 2007
--- March 2008 was the 5th consecutive month of year-over-year drop in miles driven
--- March 2008 drop was 4.3%, the largest drop since record-keeping started in 1942 and the first time there was a drop in demand in March since 1979
Is the run on crude oil over? Are you shorting oil today? Are you buying dollars?