Trading Oil: The Bears and Iran Are In Charge For Now

| About: The United (USO)

seven days editorsMark Sturdy & John Lewis submit: We have been out of Oil for a while now in our portfolio. Our last trade was a bull position which we closed out for a profit in late July at $75. Prior to that we had enjoyed the fast bull move from early December 2005 from $61.30. But now the situation needs careful thought.

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The Macro Trader has been bullish on Oil for many, many months and although in recent issues we have advised a square position short/medium term, in the very long term we remain bullish.

The reason for the market’s lack of dynamism over recent weeks is essentially two-fold:

- the now widely accepted slowdown in the US economy which led the Fed to pause its long-run policy of tightening interest rates, and more importantly,

- The inability of the major powers to agree a common strategy for dealing with Iran.

We highlighted these factors in the last three issues of The Macro Trader’s Guide:

- On August 22nd we said: ‘We are currently square of this market but expect it to find support around these levels, demand from the US may cool but any deterioration in the crisis with Iran will see this market rally again’

- On August 29th we said that ‘while Oil prices could easily push back up towards US$80.00 a barrel on any new major developments, it would probably take the threat of military action or a surprise air strike, to force the market any higher,’ and

- On September 5th we said ‘traders should maintain a square position, since it is currently impossible to put a time frame in place around expected events.’

Although the cooling US economy and the resultant reduction in demand for Oil that that implies is important, we see it as a subsidiary development to the more serious issue driving the Oil price: namely the crisis with Iran.

For now, the Iranians must feel as though they have been let off of the hook. They have openly defied world opinion and the entreaties of the world’s major powers. This is because the major powers are unable to agree a strategy for dealing with Iran, at any thing other than the lowest possible common denominator.

At that level sanctions aren’t even on the table as an option. Russia, France and China have repeatedly said they are against coercion and believe only diplomacy will achieve a resolution. After months of diplomacy culminating in Iran being offered a very accommodative package, which they rejected, it is difficult to share their faith.

What does all of this mean for traders?

- Without the threat of sanctions Iran will continue with its development work, and Oil prices will at best mark time and now actually look capable of trading lower. In the absence of real pressure from the major powers, Iran won’t have need to use oil as a weapon, and

- With the US economy cooling, the supply/demand balance argues for lower oil prices.

- Until the major powers either agree to pressure Iran through sanctions, or the US and its allies resort to military action, we will not see oil attempt to regain the previous highs. Agreement looks remote, and military action looks a long way off.

The UK is militarily over stretched in Iraq and Afghanistan, and in the middle of a forced change of Prime minister, by members of the ruling Labour party. So the UK is in no position to embark on a new military adventure. As the closest ally of the US that deprives Bush of any semblance of a coalition of the willing and with his own popularity at home very low, another military adventure would go down like a lead balloon.

However, so important an issue is Iran for world peace that we know this crisis will not just melt away. At some point difficult decisions will have to be made and that is why we remain long-term bulls of Oil.

But for the short and medium-term bulls should trim their positions while bears have had a decent move and may yet see another 4 – 5 Dollars in their favor, but if not already short, a square position makes sense in the current environment.

Mark Sturdy & John Lewis are editors of Seven Days Ahead.

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