Is the Oil Index Set to Fall?

The ETF that tracks the US Energy Sector (IYE) is starting to show signs that it may be ready for a real fall. As there has been a significant increase in the noise surrounding sky-high oil prices and regulators and politicians looking to increase oversight, they will surely end up trolling for a scapegoat.

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Will that cause some of the recent froth to be lifted from the energy stocks? Maybe. Take a look at the index and think about the timing potential for ETFs that short similar indicators/indicies such as the UltraShort Oil & Gas ProShares (DUG) which has a 200% negatively correlated price to the Dow Jones Oil and Gas Index. We have been adding that position to client portfolios recently.

The chart shows a recent break below the 50 day for IYE. All things considered, I keep on recalling the phrase: Trees do not grow to the sky.

Thoughts?

Disclosure: Clients of Horowitz & Company are LONG DUG at the time of publish.

Comments

[BM1087:]

Bring it on! There was no reason for corn to spike yesterday in tandum with oil over Libya's rethoric. Pure speculation is driving commodity prices and we all know it. CFTC is ready to flex its muscles and Congress is backing the play (and so are the working class). Can't wait for payback time with the commodity bulls.

2008 Jun 27 08:57 AM

[noam:]

Oil will come back down when supply increases or demand decreases. Until we see any sign of either, I would be very wary of DUG. Many wise and sophisticated ivestors got their fingers badly burned betting against oil, the latest one being T. Boone Pickens...

2008 Jun 27 09:02 AM

[fxtrader07:]

shorting crude outright makes more sense as the oil stocks (major producers) have lagged badly and are priced for crude at 100-110 rather than 140. That saidm, short term stock market pressure might drag oil stocks lower first as was evident yesterday. crude up 5$, oil stocks down 1-2%. over the medium term however, oil stocks will catch up to the price of crude or vice versa. long COP (or a basket of major oil stocks) and short USO seems to be an obvious winning trade over the next 12 months or so.

2008 Jun 27 09:22 AM

[Greg Pinelli:]

One f the few worthwhile articles I've read on Alpha...shorting the index with DUG makes far more sense than shorting oil...the nasty little delusion being held close to those who can't or won't study oil/gas markets in depth is that there is little speculative over hang and very tight supply..now and in the future. IF supply were plentiful..and demand moderated the longs would get killed. But its not..and demand destruction is still in the future.
DUG is NOT a bet against oil..it is a bet against oil/gas related companies. Oil could stay precisely where it is and the markets could get hammered by continued WORLDWIDE subprime related issues and these companies would fall with the markets. Anyone looking at a chart right side up can see IYE is extremely overdue for a severe correction.
As for corn?? Maybe bm1087 hasn't heard of the Midwest floods...immature corn fields? Uncertainty relating to corn survival rate?? It's in the news..you should try it sometime.

2008 Jun 27 10:31 AM

[whidbey:]

georealist has hit it on the head. I see the consolidation and have been out but not short the firms since they have not been attractive for some time. I think that tells us the play is on the commodity itself and therefor risky. I think the same in gold as well. We could be setting up for a massive correction in the commodities at which time the producers will be attractive. Long run we have a problem called inflation. Later, maybe deflation.

2008 Jun 27 12:07 PM

[300mph:]

I hate to rain on your party here but the DUG is broken. It is not performing as indicated, double inverse. From May 16 through today the USO is up about 12% and the DUG is unchanged. In this period DUG has a tracking error of 24%. Why would you buy an ETF that performs this badly relative to its stated objective?

2008 Jun 27 12:39 PM

[Chickenpookie:]

300mph - Slow down a bit, stop and smell the roses!!! DUG is 2x the Dow Jones Oil and Gas Index. Compare DIG and DUG to DJUSEN and you'll discover for yourself!!!

2008 Jun 27 08:49 PM

[Panskeptic:]

Since commodity ETFs hit big, there have been a lot of bad decisions made by investors more comfortable with stocks.

I'm glad these commodity ETFs are there, we don't need to be protected from them, they've been good to me. But don't try to do it just on charts - you really need to understand seasonality, supply and demand factors and a fairly exotic brand of headline risk.

Commodity ETFs may trade as stocks, but they're not stocks, and the investor will get spanked repeatedly until the lesson takes.

2008 Jun 28 12:51 AM

[MNSL:]

An excellent article

Yes definitely all hot commodity indexes including oil index will come down soon.

Very soon we will see collapse in the commodity market similar to property market. We are in the bubble stage now.

Oil prices will come down sooner than later.

This is the time to short all hot sectors such as oil and other hot commodities.

2008 Jun 28 05:32 AM

[madeconomist:]

I agree oil will fall. If you look at where the oil prices are today, they look scarily similar to where the dotcom stocks were back in 2000 and real estate was back in 2005. Looks like its just a matter of time now. The question is how much would it fall? Most people will think that I have gone crazy, but I don't see any reason why oil should be priced at more than $80 per barrel, after taking into account all the possible risks and demand

2008 Jul 16 06:50 PM