TraderRob's  Instablog

Dow components Caterpillar (CAT) and DuPont (DD) are draining the will of investors to remain vested shareholders, as CAT posted its first loss since 1992 and Dupont lowered its 2009 guidance. U.S. stocks weren't the only misfortuned securities Tuesday morning, as crude oil future prices for May and June delivery felt immense downward pressure below $45/ barrel in early trading. Reports continue to roll tape, reporting crude inventories' sustained rise to record levels, amidst the sharp sentiment change with respect to U.S. equities and the derived prospect of a global economic turnaround.

While fundamental issues and speculation are affecting NYMEX and WTI crude spots, the real squeeze Tuesday morning was the result of the short term glut between monthly prices, known as "contango". Contango is broadly defined as the upward sloping curve of future contract prices over time. As contracts approach the trading termination date, the price of the contract becomes volatile. In bull markets, the steepness of the futures curve can pull the contract nearing termination higher, while bear markets allow price decay in near term contracts to drag down longer term future values.

100 million barrels worth of crude tankers floating off the U.S. coast, the EIA estimate of crude inventories nearing a record 370 million barrels and the recent predictions that demand for petroleum based products will deteriorate throughout 2009, set the stage for the oil sell off on Monday. Tuesday morning trading accounted for poor U.S. corporate guidance, futures termination, and the harsh crude fundamentals previously identified, causing May contracts to crash below $45/ barrel. 

Throughout the day Tuesday, crude oil futures recovered and May delivery contracts appreciated towards June prices. The oil futures curve actually remained relatively unchanged, upon May future expiration, as U.S. equities improved, however the true colors of crude trading sentiment were shown in the early hours. The market opened Tuesday as if the bottom had fallen out, as a vicious decline in NYMEX crude spot prices resulted from May delivery contracts falling simultaneous to price decay in future contracts four to six months out. One would expect near term oil futures to react to investors' sentiment but not for the futures curve to maintain its slope and drop in tandem with short term contracts. This reaction of long term contract prices signals the timid lack of confidence among commodity traders and solidifies the argument that crude oil is now reactionary to the U.S. equity market in the short term.

The potential for crude oil to fall steeply from its current level to spot prices closer to $40/barrel in coming weeks is high. Pay close attention to the EIA Petroleum Status inventory levels, mortgage applications and U.S. equity strength on Wednesday. If you subscribe to the theory that equities are due for a pull back, expect to make generous profits shorting crude with an entry point around $47.50.

Disclosure: Short USO