A Great Day To Reduce Risk And Sell/Short U.S. Shale Oil Producers

Includes: LNGG, LQD, PXD, USO, WLL
by: Robert Duval


Celebration on Greece talks incite a big rally.

The real story to watch is inflation expectations and Interest rates, particularly 5 year rates.

Excellent opportunity to reduce risk and sell / short US Shale Oil producers in particular.

Today we have had a big oversold rally in the indices; + 236 points on the Dow with a primary catalyst being celebrations over a Greece refunding deal.

However, I was a heavy seller and even initiated several short positions as well as reducing long side risk, because in my view what's happening in Treasuries is turning out to be the real story of 2015, and a potentially far, far bigger story than Greece.

Once again, per my last article it's all about the Bonds, and the debt exposure of US shale producers combined with an oil rally that appears to be -- pardon the pun -- running out of gas, means it's time to aggressively sell this sector in particular, and be wary of high PE sectors, as well.

Levels I am looking at in terms of interest rates would be major resistance on 5 year rates (FVX) at 1.85%, as you can see we are there:

^FVX Chart

^FVX data by YCharts

Long rates have had a huge move too: (TYX)

^TYX Chart

^TYX data by YCharts

And corporate debt (NYSEARCA:LQD) is definitely starting to weaken in response, which may be the canary in the coal mine for some sectors:

LQD Chart

LQD data by YCharts

It's all about the debt levels and leverage, and after 6 years of low rates and ever expanding leverage and valuations, at least some sectors are vulnerable to a rate adjustment. Essentially, the bond market is the tail wagging the dog, and the bond market is telling the Fed it wants rate hikes!

Turning to oil itself, (NYSEARCA:USO) appears to be -- possibly -- forming a bear flag:

USO Chart

USO data by YCharts

The fundamental rationale for continued weakness in (shale) oil producers, and perhaps the price of oil, is as follows: (credit to Briefing.com)

"The US producers have every incentive to push production back up to all-time high levels already.

At the same time, OPEC is handcuffed from being able to do anything about it, except up their own production. Since we are already sitting at record levels of inventory storage (glut), one cannot help but think this is going to lead to another sharp price break before long.

If you are an individual producer here in the US, and you do not bring capacity back online that you shut down in Jan-Mar as soon as the market seems like its healing, and your competitor does, then you are making a sacrifice for the good of your competitor, taking a hit to your revenue stream in order to keep supply tighter in the marketplace so your competitor can make more by pumping more.

Right now, it is in the best interest of every big producer to pump as much as they possibly can, no holds barred. That will create a group outcome that none of them want. This is the defining dynamic in any commodity bear market, and has played out many times before.

While recent data is improving, there is no way to avoid the over-supply consequences that the system is pregnant with right now."

I am short the following three producers that I see have political [Canadian Oil Sands (COS)] and/or debt issues [Pioneer Natural Resources (NYSE:PXD) and Whiting Petroleum (NYSE:WLL)]. Another strong avoid, which I have tried unsuccessfully to short, is Linn Energy (LINE).

COS Chart

COS data by YCharts

PXD Chart

PXD data by YCharts

WLL Chart

WLL data by YCharts

To summarize:

History has never charted a period when rates were zero for this long, so simply, the simplistic statements I've read in various forums that the S&P 500 must go up during the incipient stages of rate rises is bordering on foolishness, considering how long rates have been this low.

How much debt of various sorts, corporate and margin investment debt, is tied to long rates staying extremely low? I don't have a precise answer but after 6 years you can bet a boatload.

My primary risk factor has been higher rates as inciting corrective activity, and I think we are there. 1.7% on 5 year rates is a big number for me and we've broken that.

Other intermediate term risk factors I see:

A) Continued weakness in transports on a multi-week basis.

B) A parabolic rise in China A shares that I think will burst at least into a nasty correction.

I remain with my group of core longs but have more than hedged with shorts for the intermediate term. This potential "lower high" large bounce is a wise day in my view to reduce risk/reevaluate positions.

I express no change in long term view with this move, I remain bullish on both the US economy, consumer, and long term US and certain international markets.

Disclosure: The author is short PXD, WLL, COSWF.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Not investment advice. Do your own due diligence, and consult an adviser. Author is not an investment professional.