USO Begs Short Position as Oil Tops $53.50

Crude began to rally early Thursday as U.S. commodity markets opened on positive news that 2008 Q4 GDP numbers were not as terrible as expected. Futures prices are completely ignoring the stockpiles of crude throughout developed countries, in the Arab world, and floating off-shore in tankers. While WTI crude futures were trading below $45/barrel they were argued to be cheap, since which time markets have priced the black gold commodity higher by 20%. The previous levels were optimistic that demand would increase and macro economic data would turn favorable.

To traders who profited from buying DIG or USO while crude was trading near $40/barrel, congratulations, take profits and reverse it. The "re-flation” trade, Chinese stimulus promises, and Thursday's less terrible than expected GDP report have provided enough froth for commodities to float above realistic valuations. Now is the time to take account of the meaningful forward indicators of economic activity and detach the rear view mirror.

The supply of crude grew by 3.3 million barrels compared to 2.0 million barrels the week before, according to the EIA Petroleum Status Report on Wednesday. U.S. inventories of crude are at levels above 360 million barrels and are higher than at any point in the last three years. Refiners are operating at 82% capacity with room to scale up production over time, yet draws in gasoline supply won't have an immediate impact on the prices of crude due to supply gluts. Refiners will moreover be less inclined to scale up production given jobless claims data released Thursday, which suggests it is unlikely that U.S. consumers will increase their consumption of fuel.

The long term trend of crude oil will be to the upside, but the immediate macro and micro economic threats make the case for active traders to short the USO, while a substantial pullback of crude towards $40/barrel will offer an opportunity to get long USO for "buy and hold" investors.

Disclosure: I am Short USO.

Comments

[Mad Hedge F...:]

The recent 69% leap in crude prices from $32 to $54 may mean that the next spike has already begun. We have been sowing the seeds for the last nine months. The US drilling rig counts has dropped by half to 1000, and it could go as low as 900. Credit squeezed companies have chopped exploration budgets to the bone. The few new wells that are being drilled are becoming increasingly expensive to bring on line. Mexico is the second largest foreign supplier of crude to the US, delivering 1.2 million barrels a day. But production at its main Cantarell field in offshore Yucatan is falling off a cliff, and the country will soon become a net importer. Buy that Prius while the lots are still full.

Mar 27 11:16 AM

[tunaman4u2:]

I think we'll see some OPEC cheating as they have been cash starved for a few months now between production cuts & cheaper prices. I wouldn't go long oil at these prices...
Its also gone up like a rocketship with the market. The market could be due for a pullback too.
Government could also crush the dollar tomorrow & Hamas could fire off a few rockets so these are the toughest times to make a sure fire call.

Mar 27 01:58 PM

[Ferdinand E...:]

OPEC will cheat because they are cash starved, 'tunaman4u2' claims. Hmm. Some cheating may take place, but I think that the majority of these countries have finally learned that cheating doesn't pay. Of course that might be terribly naive on my part, but in my opinion it would be a good thing if our political masters thought the same as my good self - even though it might be incorrect. Better that they went along with my hypothesis than if they believed that bargain basement oil was right around the corner.

Mar 28 09:10 AM

[donzelion:]

I stopped dollar cost averaging into USO and oil stocks two weeks ago as it started going up, which makes me almost even (started going into USO in October when it seemed it couldn't possibly fall any lower...oops). Do wish I'd disregarded the whole thing and just put my money into dividend paying stocks (just filed my first set of taxes with USO - still not sure I did it right, but no new form is a pleasant experience for me).

At these valuations, I see oil as more of a "store of value" - inflation/deflation/mo... instability protection, rather than an "investment." Everyone talks about gold as the "Mad Max" investment - but the battles I recall from the Road Warrior weren't about gold...

Mar 28 09:44 AM

[MasterSquare48:]

Oil was down (and may continue to move lower for a few more days) as a result of profit taking. There's a correlation between oil and uso, and as long as the market continues to move higher, which it will until around 850-875 on the S&P, look for oil to continue going up. We may trend back down a bit after that, but ultimately the S&P is moving to higher grounds... 950 or 1000. We are in an up trend at the moment, while being in a general downtrend (a bull in a bear). I see oil at 60, before 40! Once all major indexes top out, then we'll start moving down (and all stocks will follow). This is when the trend reverses and we start going down hill again.

Mar 28 11:49 AM

[VSD:]

The inventories of 360M is not enough to hedge against the next spike in oil prices. In summer you will see draws of 6-7M barrels from inventory.

Mar 28 12:27 PM

[aware:]

If oil goes back to even near passed prices this country will collapse.

Mar 28 01:00 PM

[Freedoms Truth:]

"[doesnt think OPEC nations will cheat] Of course that might be terribly naive on my part"
I think so. Consider that some OPEC nations might cheat out of necessity to keep state budgets from imploding.

Mar 29 12:15 AM

[Hmm?!:]

Whether OPEC cheats or not, OPEC will remain.

Most of the time when OPEC has production cut rumors before a meeting or announces a cut, the price of oil jumps a little. Hence OPEC can cause price jumps to sell into...... they can effectively make some extra money just by opening their mouths.

Pretty sweet and lucrative deal for them.

Mar 29 03:09 AM

[Chezfrederick:]

With oil futures in contango, USO has a built in price decay as the roll over from the front contract to the next takes place. Therefore, shorting it when you believe oil prices may decline, actually gives you a good lift beyond the simple reduction in oil prices.

Pesonally, I am not convinced that oil prices are ready for a correction as I see the USD weakening in the coming weeks pushing oil and commodities up.

Mar 29 11:26 AM

[NYTReader:]

If oil is to go back to record prices you might want to know if Goldman Sachs is pumping it (through J. Aron & Co., its commodities trading arm).
www.forbes.com/forbes/...

Mar 30 12:54 PM