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The Refined Investor
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Educational and entertaining daily reports on the market with an emphasis on risk management. Creator of the TEMPOS System.
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  • Crude Oil Preparing For A Massive Move 2 comments
    May 6, 2013 2:22 PM | about stocks: USO, DBO, OIH, GLD, SLV, GDX

    In my previous article, Pre-Fed Deflation Trade, I talked about how the market was showing signs of deflation and I had been positioned in (NYSEARCA:TLT) and (NYSEARCA:GLL). However, the language of the recent Fed Statement hinted not only to continued Quantitative Easing (QE) but the possibility of increased QE in the future. That same day I sold my long-term treasuries and short gold positions in order to entertain the possibility of a higher level of inflation.

    When thinking about inflation, most people immediately go to precious metals such as gold (NYSEARCA:GLD) or silver (NYSEARCA:SLV). However, within a secular bull market in commodities many times different assets will take turns spiking in price as they rotate in and out of favor with investors.

    While I am bullish on gold and silver in the long run, I believe we are soon about to witness a large move in crude oil (NYSEARCA:USO). I study the fractal energy of prices, and when there is a lack of volatility then it means the potential energy is building up for a big move.

    What could be the cause? I believe fundamentally it could be caused by a decline in the US Dollar (NYSEARCA:UUP) and increased geopolitical risk over the summer. Also, because the stock market is currently sitting at all-time highs, investors will often look for more undervalued areas with higher growth potential similar to what happened in 2007-2008.

    First, let's look at the US Dollar and the path that it is following:

    (click to enlarge)UUP Intermediate CycleRecent strength in the Euro, Pound, Loonie, and yes, even the Yen, has the chance to put significant pressure on the dollar this summer. The dollar is currently forming a downtrend of lower lows and lower highs, and should eventually break below the February lows by the end of the summer.

    Because crude oil is very sensitive to weakness in the dollar, let's look at past instances where the price of crude has consolidated as tightly as it has right now:

    (click to enlarge)Crude Oil BB Width Monthly

    Surprisingly, we have to go all the way back to 1995 to find a time when crude oil had this much fractal energy on the monthly charts! The last two times that crude was wound this tight preceded moves of roughly 40% in both directions!

    Let's also take a look at the weekly charts to make sure that they are confirming the same potential energy:

    (click to enlarge)Crude Oil Weekly

    Just like the monthly charts, the price of crude oil is squeezing tighter and tighter with tons of fractal energy. This is very important because the last time that crude oil made a big move higher was in 2007-2008 just as US equities were sitting at all-time highs.

    What did the situation look like in 2007-2008?

    (click to enlarge)WTIC SPX RATIO

    That's right, just as US equities began to roll over, the price of crude oil dramatically outperformed stocks in an almost parabolic move. The price of oil jumped dramatically from a low of $50.55 in January of 2007 to a high of $147.27 in July of 2008, even as stocks were declining.

    Will it happen again? The potential is there, and the fundamental decline of the US Dollar could definitely provide the necessary boost.

    To balance out the argument, price can always break down out of a consolidation and so it is safer as an investor to wait for a breakout move to happen than to front run it. An entry on a breakout from the consolidation with a predefined amount of portfolio risk and clear exit point would provide a favorable risk/reward investment.

    What instruments would be best to take advantage of such a large move? Assuming that you're not trading futures and looking for a non-leveraged position, the US Oil Fund, PowerShares Oil Fund (NYSEARCA:DBO), and Market Vectors Oil Services (NYSEARCA:OIH) should see significant outperformance on a break higher in crude oil.

    Good trading all.

    Steve Chapman, TRI

    Disclosure: I am long OIH.

    Additional disclosure: I may purchase a crude oil ETF on a breakout from the triangle.

    Stocks: USO, DBO, OIH, GLD, SLV, GDX
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Comments (2)
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  • Bob K.
    , contributor
    Comments (64) | Send Message
    I am with you on this trade Steve. There are so many names ready to bust out it isn't funny.
    7 May 2013, 07:52 PM Reply Like
  • 24ALEX
    , contributor
    Comment (1) | Send Message
    That's a nice comprehensive report and some good charts to reflect on. You said , " last time that crude oil made a big move higher was in 2007-2008 just as US equities were sitting at all-time highs."


    I hadnt thought of that recently , glad you mentioned it.


    I would imagine higher risk, less conservative traders would also go to DUG for leveraged gains.




    7 May 2013, 09:17 PM Reply Like
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