Over the last week or so, ever since oil topped the $140 mark consistently, I have been tempted to recommend a short position on oil. Today, after two days of oil selling off, I am still in a conundrum.
Let's review why oil is where it is:
- Demand story is still very much holding true with China and other developing nations building out their oil reserves and infrastructure.
- Dollar is weak. It is safe to conclude that the dollar has contributed at least $20-30 increase in the price of a barrel of oil over the last 6-8 months.
- Global instability has never been more of a factor. Venezuela, Nigeria and Iran remain a threat to the US oil supply and Israel's recent tactics towards Iran have not helped matters.
- Speculation is at large. Successful traders have been shorting financials and buying oil contracts therefore driving the price of crude oil to unimaginable heights in a relatively short period of time. Hedge funds reeling from the losses in the financial sector have also turned to energy and in doing so have driven up the price of oil.
So what is changing? Well, demand is starting to taper off a bit. India's economy has slowed down, as has Eastern Europe. China, too, looks to be slowing down, although not by much.
Dollar weakness continues, but the sell-off in commodities, if it turns out to be more than just your average pullback, indicates that the dollar might be done going down. Moreover, the Fed has recently done everything in its power to help the economy by injecting money into the market. Rates cannot possibly go any lower and there isn't much more that the Fed can do except to raise rates to curb inflation. That should increase the value of a dollar, which should help bring down the price of oil.
Global instability is really the only X-factor. It does not seem to be going away and will continue to harass the oil markets.
Finally, speculation is only as good as the last trade. If oil declines a little more here, the same traders will start shorting oil. At that time, I would anticipate the financials to start recovering meaningfully as well.
So what do you do with oil now? I certainly wouldn't be long oil here, but I wouldn't short it here either. We need to sit tight until we see a trend emerging.
Full Disclosure: I do not own oil in my portfolio but my position can change anytime without notice.