Don't Be Tricked Into Buying The Oil Bounce

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Includes: BNO, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Matthew Allbee

Summary

Oil rose 8% today, despite a larger than expected supply build, in reaction to a sharp decline in the U.S. Dollar.

Despite this dramatic rise, it is important not to fall into the trap of chasing a dead cat bounce.

With no real reason to believe oil should continue upwards, and evidence that it could come down instead, this is a trade you should stay out of.

Despite EIA Crude Oil Stocks (NYSEARCA:USO) change came in at +7.792M, much more than the +4.76M analyst estimate. prices of the commodity soared 8% for the day. This has certainly led many to buy in, hoping the meteoric rise would find a reason to persist.

The problem with this is that there was zero reason for oil, on it's own merits, to bounce today. The supply glut is only continuing to worsen, as shown by the EIA number released today. Oil rose today only because U.S. data releases showed a weaker than expected services sector; by far the main driver of the U.S. economy. The market decided based on this info that the chances of further Fed rate hikes suddenly became much less likely, and the Dollar plummeted. As the USD plummeted, assets priced against it rose; such as oil.

No positive changes have occurred that should push oil markets upwards. On the other hand, the unexpected growth in supply means the situation for oil has actually gotten worse. Still, many are attempting to attribute significance to this rise that does not seem justified.

Take this CNBC-hosted article for instance. In it, Robert Yawger, the senior vice president of energy futures at Mizuho Securities USA, re"People say 'I think the market has bottomed. There's no place left to go from here but up.' " This quotes is literally the definition of irrational exuberance in markets. When market participants have largely decided that a market can only move in one direction, especially with little evidence, they are almost certainly wrong. Irrationality can't hold forever, and you don't want to be one of the unfortunate bulls when the pessimistic reality takes over yet again.

If the U.S. Dollar had remained stable throughout the day, oil prices would have fallen; possibly steeply. The fact that they did the opposite reeks of a market ready for a correction. If you believe the U.S. Dollar will continue to fall, just short the Dollar. Hoping oil will continue to advance against the backdrop of bad news is a mistake. Don't make it.

Disclosure: I am/we are short WTI CRUDE.

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