Everyone loves to ride a bull market. It’s only natural: we’re hardwired to go with the flow, because we’re social animals who work in groups. However, in the world of trading, that can quickly turn into a deadly trap.
That is clearly the case when it comes to oil. There has been an extremely violent short squeeze in the USO (NYSE:USO) Crude Oil ETF, sending the oil price very high, very fast – and several aspects contributed to this.
Persistent and repeated claims by one OPEC minister after the other, saying that production cuts were coming. No cuts were announced, but a softer measure was actually put forward: a production freeze. Still, not even that production freeze held because Iran said they would not freeze anything. Then Iraq said they wouldn’t either, if Iran were to be left out of the deal. Now, Kuwait came out and said that they’ll go “full power if there’s no agreement” that includes Iran. So, the OPEC claims, promises and hopes are quickly fading.
The short squeeze is fading too and seems to have run their course. The EIA has said today that “production is more resilient to lower prices than previously expected”, suggesting that oil producers can, after all, withstand low oil prices for longer without fully breaking the bank. And banks, on the other hand, do not want to have all these over-leveraged and highly indebted oil companies and their equipment and oil fields repossessed, because that’s not their core business. They don’t know how to manage oil companies, so they’re likely to have participated in this short squeeze to send prices higher, and they’re not keen on taking oil companies down, because their assets would not convert into liquid cash that banks could use.
If we look at China, a very large oil consumer, it doesn’t look like it’s going to need a lot more oil anytime soon, considering its economic slowdown. And the cushing figures are staggering. In some places of the world, it costs more store oil inventory than to actually buy oil.
So, while it is possible that oil can keep rising for some time more from its current prices, the truth is that such a move is not backed by any fundamentals. This means that now may be a very good time to go against the flow and find value in oil by shorting it, possibly by shorting the USO that rose due to this short squeeze.
Remember that oil production nations like Venezuela, Russia, Nigeria or Saudi Arabia need to keep pumping to feed their national budgets, so it is very likely that oil will keep going down for the time being. So you can probably make a better profit by shorting oil where it stands right now, than by going long on such a stretched market.
When it comes to the forex market, you can trade this indirectly by going long USD and shorting currencies of oil producing countries, which have seen a temporary rebound, such as the MXNor the CAD.
Just make sure you don’t forget that, promises of OPEC members aside, the market will ultimately trade on fundamentals, and that the world economy is currently headed towards forced deleveraging, which is bad for oil.
In the long run, however, if oil does come down and hit the $20 mark, then that will seem a very good trade signal for an entry point that is sure to make money, long-term. After all, despite the short-term turmoil that we’re seeing, long-term, the world is only likely to keep needing more oil. Not less.