Traders Offer Easy “Go Long” Oil Opportunity


Summary

Traders trade, that’s what they do, don’t listen to their stories though.

Oil is at the bottom of it’s new range, it’s an easy buy once again.

The intermediate bias in oil is bullish and so is the short-term.

Buy oil ETFs as futures swing back to backwardation from contango.

Traders, from time to time, give us slow handed folks a wonderful opportunity. The traders will beat down or drive up an asset to silly price levels, unsupported by fundamentals, setting up high probability reversal trades. That’s the land I trade a bit. 

If you watched my last several webinars, then you saw how my group of slow handed position traders, who occasionally swing trade, were able to sidestep the October correction and get into the PowerShares QQQ ETF (QQQ), Tesla (TSLA), Amazon (AMZN), Googlebet (GOOG) and First Solar (FSLR) very close to recent bottoms. 

How did we do it? Well first, we understood what was really driving the stock market, which was the stock buybacks. So as not to rehash, you can read all about it here in my Editor’s Pick 4th Quarter Macro and Market Outlook, and a follow on piece – Q4 Portfolio Playbook Review.

Right now, the traders are giving us another wonderful set-up to jump into. This time, the trade is in oil, something we have fairly successfully traded the past few years. 

Oil TradingIf you are inclined to trade a good setup, then it’s time to buy the U.S. Oil Fund (USO) or for the more assertive, buy the U.S. 3x Oil Fund (USOU). 

Traders Trade

Traders trade, that’s what they do. They also offer wonderful narratives of why the market they are betting on is going to go in the direction they are betting. Why? To try to get others to make trades that move the market in their favor.  

An honest trader will tell you their wagers are simply moving with the market trend or looking for a reversal. They could be a technical analyst or quant, it doesn’t really matter, they have a trading system and are going with it. 

The less honest trader will tell you a story about why you should believe in something or not believe. If you follow traders on Twitter (TWTR) or StockTwits, you will get wonderful narratives about the fundamentals and other important, but misunderstood or unknown information, supporting their trades. They’re pithy, clever, emotionally compelling and oh, so very, very wrong most of the time.

About a fifth of traders make money getting in and out ahead of the crowd. The others are losing or wasting their time. To the extent the good traders and the wannabes can convince you to make trades you don’t fully understand, they win a bit more. 

Why Oil Prices Really Fell Recently

A confluence of factors weakened oil prices leading up to the midterm election:

  • Demand growth, following the peak summer driving season, slowed a bit.
  • American oil production peaked at 11.6mbd [EIA] for the next few quarters.
  • American refineries took in less oil last month as they did maintenance.
  • Saudi Arabia used about million barrels of their spare capacity (they had about two million in April) to add inventory to global oil markets. 

Along with those important factors, President Trump jawboned down oil prices a bit and Wednesday took full credit for lower oil prices saying he issued waivers from Iran sanctions to keep oil from going to $100 or $150 per barrel. Let’s think about that. 

Oil supplied to the world from Iran has declined about 1 million barrels per day since sanctions were announced a few months ago. Saudi oil increased about a million barrels per day. Seems it should be about a wash. 

The real impact of the waivers, made to nations that had substantially reduced oil imports from Iran, is to give them several more months to continue reducing those imports. While nations like India and China will never get to zero Iranian oil, the money is getting segregated so as not to support terrorism and be directed to humanitarian needs (which won’t be 100% effective either, but it’s a pretty good set of goals).

Regardless of reality, traders sensed the top of a range for oil prices about six weeks ago and put on the reversal trade. They have been throwing out bearish narratives ever since. The one that has gained traction lately, is that next year, oil demand growth will be a half-million barrels per day less than previously anticipated. So, growth in oil demand, just not as much. Predicated on a global economic slowdown, predicated on an expanding tradewar. In other words, a lot of breathy speculation.

That leaves us in an interesting spot as oil prices have reached a level that I told members of my services to watch for: 

Kirk Spano @kirk.spano Moderator

Leader Nov 2, 2018 7:17 PM margin-of-safety-investing

“Herald59 well, you’re sort of sniffing something out there. I’d suggest this. Visualize how the curves have moved. Is the pullback indicative of a complete reversal or is it a fluctuation within a new range. I think it’s a fluctuation within a new range and the move is higher over time, meaning back to backwardation. Traders keep banging the contango drum past few weeks (which I mentioned). Why? It helps their trade. Remember, most traders lose. That is a fact. It’s overwhelming. Many losing traders pile into a trade and adopt the narratives, repeating, making themselves believe, then losing when the market does something wrong, not them. So it goes. It is true that WTI is in contango. That is absolutely true. Thus, avoid the trade. I think the market turns (as I’ve said) at about $62 per barrel, and we’re very close to that. So, alacer makes a very valid observation on the entry for now, which is to avoid. That could change by next week. If I go long USOU again I’ll let you know.”  

Here’s Why Oil Prices Are About To Rally Again

If you read and listen carefully, the traders are about to start changing their story. There will be speculation that President Trump and President Xi are about to cut a deal or at least “keep working on it.” A few will also talk about big draws from refineries that were down on maintenance last month. I’m not sure what else they’ll come up with.

The reality for the traders is that the really good ones will want to change direction. Once they are positioned, which I believe is just starting to happen, that’s when the narrative changes as they have to bring along the herd.

Here’s what is really going on fundamentally that will support the short and intermediate term bias for oil to be bullish into the next recession. 

  • High-grading of both shale and less deep offshore is depleting the cheapest to get oil. This is the most important intermediate term and long-term trend.
  • The Permian Basin, responsible for most shale production growth, is on a growth pause until spring as they await more pipeline capacity late in Q2 through the end of 2019.  
  • Canada is done with significant oil sands development and has only minor expansions of existing projects likely to go in the next few years.
  • Other shale basins are peaking in production now and some are already turning over to slow declines that will become massive declines by the late 2020s (or sooner). 
  • The Saudis are nearly out of spare capacity and will require billions of investment to increase capacity to reach their less cheap oil. They will have to think carefully about how much they want to extend themselves on doing that while trying to diversify their economy.
  • Saudi Arabia needs oil in the $80-90/barrel price range to make enough money to fund their budget and Vision 2030 economic diversification project.
  • Iranian oil won’t come back to the market until at least the early 2020s. 
  • Offshore projects by the majors in nations like Brazil, Guyana and Algeria have breakevens above $40/barrel (over life of project with large upfront commitment and a long payback period that might impact actual development) and will not start producing until the early to middle 2020s. 
  • The North Sea is hanging onto production levels with better technology, but breakevens are likely to rise in the next few years.
  • Demand continues to rise as more people enter the middle class in emerging economies. This is unlikely to change until at least the middle 2020s and possibly later as I discussed in Exxon And Chevron No Longer ‘Forever’ Stocks.

The Swing Trade To Make In Oil

Currently, near-term oil futures are in very slight contango. Contango leads to a deterioration of asset values for ETPs (exchange traded products) that track commodities. In short, it is more expensive to roll futures contracts forward from month to month. That eats away at ETP pricing. Beware contango. 

That said, I believe the contango WTI is a temporary condition that is about to change. I believe we are likely to see backwardation, which is favorable to ETPs, return within weeks.

In the above linked graph, see the Hi/Low Limit. The “Hi” represents the high price paid for that contract. The “Lo” the low. As the price of spot oil rises that makes it more favorable to sell oil now, than hold onto it and spend money to roll contracts at higher prices.

It easier to think about futures when considering this very simple thought: is it better to sell your oil now or hold it into the future? If it is better to sell it now, then you are in backwardation and that is good for ETFs and ETNs (together ETPs). 

The U.S. Oil ETF (USO) which tracks WTI Crude has come down in price as the price of oil has come down and slight contango reappeared. This year, the market was in backwardation and you can see that USO outperformed the spot price of oil.

USO Spot Price of OilThe opposite is true when contango is happening as was the case prior to spring.

USO WTI Crude PriceThe leveraged ETF tracking oil is the U.S. 3x Oil ETF (USOU). The 3x daily leverage created outperformance with oil prices rising despite despite slight contango prior to spring. 

USOU WTI Crude PriceHowever, as oil prices fell the past month, all of this year’s outperformance of USOU vs WTI disappeared. 

USOU WTI Crude PriceThe takeaway here is that with minor contango or backwardation, the price direction of oil is the big factor in whether or not to invest in oil.

Given extremely strong fundamental support around the $60-62 price range for WTI Crude I am a buyer of both USO and USOU. 

Buy the U.S. Oil ETF (USO) if you want to be long oil, but do not want leverage.

Buy the U.S. 3x Oil ETF (USOU) if you are more willing to take the risk of oil prices continuing to fall, the leverage could make you a big winner if oil prices reverse in coming weeks as I expect. 

Note

I am going to publish this article publicly after you have had a few days to establish a position. 

This is an example of swing trades I will make available at the new service I am opening around Christmas. The swing trading service will have 2-3 active trades per month and usually a bigger trade that lasts a quarter or two, in addition to all the other content you currently enjoy. 

Disclosure: I am/we are long USOU.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I intend to go long USOU imminently. — Disclaimer: I own a Registered Investment Advisor – Bluemound Asset Management, LLC – however, publish separately from that entity for self-directed investors. Any information, opinions, research or thoughts presented are not specific advice as I do not have full knowledge of your circumstances. All investors ought to take special care to consider risk, as all investments carry the potential for loss. Consulting an investment advisor might be in your best interest before proceeding on any trade or investment.