Crude oil prices are approaching $99/bbl on Nymex. We think that crude oil will have many problems in justifying a price above $90/bbl. Current prices are at least 10% higher than the price justified by even the strongest projection for the demand. So oil is a good candidate for shorting the commodity at these levels.
The problem with oil is that it's not a demand issue at all for the current price rise. It's totally a supply issue driven by on and off headlines from the Middle East and North Africa. But as traders we are always cognizant of the fact that such supply issues are highly transitory in nature. In fact, higher oil prices will try to moderate the demand even further as people try to drive more economically in the short term and buy more fuel-efficient vehicles in the long term.
The spike in crude is solely driven by supply issues at this point and is accentuated by the fact that yield seekers (institutions borrowing at 0% from Fed) quickly jump onto any trades that promise 1-2% return within days. So we are not surprised by the move at all. And I think that's the reason even Mr. Bernanke is not too concerned; because he knows that the same big move will be on the downside as well as soon as the yield seekers have realized their expected yields. I think that point is not too far. And crude oil at these levels can tumble 4-5% within days and more than 20% in the next month.
US Oil (NYSEARCA:USO) is the crude oil ETF and can be shorted at the current level of $40. This is the easiest way to take a bet on falling crude prices in the near future. From a technical perspective, USO will form a head-and-shoulders pattern in the next month. So if USO falls below $39, then a further drop of 10-20% fall in USO can be expected. RSI (Relative strength index) for USO is also reaching the peak level. These patterns clearly indicate an imminent pullback in the USO and crude oil prices in general.
It's not sustainable for crude oil to stay above $90/bbl for the long term as demand for the crude now adjusts very quickly. Also we don't think that apart from speculators, supply side of the crude oil also warrants these prices. We saw UAE and other major oil producing nations being fully committed to production to bring the oil prices to more normal and sustainable levels.
Shorting crude oil or USO is a good position to take at this point as return on short side far outweigh returns on the long side of crude oil at the current price levels.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in USO over the next 72 hours.