Wednesday, May 21, 2008

Short oil because of excessive speculation?

It’s weird how normal $100 plus oil suddenly seems. Oil has gone parabolic, and this chart from Bespoke Investments seems to suggest that things could be getting toppy.

Speculators are not very popular right now. Futures trading in many commodities across the world has been banned. Numerous experts have spoken out that most of crude’s price today is due to "speculation" and a "strong inflow of funds". Indeed, I came across this interesting article where an analyst was commenting on the rampant speculation in the oil space:

Fadel Gheit, an oil analyst at Oppenheimer, said record-breaking prices are a result of pure speculation by hedge funds and commodities traders, not a result of negative market fundamentals, adding that there is no real supply shortage.

"But rumors and speculation have taken over the market," said Gheit. "For example, even if the oil company is shut down, which Russia would not allow, they could maintain their current export volume, because they are limited only by capacity, not by production. And Russia has plenty more oil waiting to be exported."

Before you run off to double your short positions, check the date. The article was published way back on August 2004. The path of least resistance has been consistently up these past few years (even with a 40%+ price correction like we had in 2006). That price action needs to be respected. While oil may very well go down in the event of a global recession, it could also double in between.

Speculators play an important role in price discovery, and just because speculation is rife doesn’t mean that prices are unstable and headed down. Speculators are trend followers, not trend creators. Judging by what the strategists are saying, we may end the year up. (Goldman Sachs is now forecasting a second half price of $141 and a super spike price of $200). Marketwatch has this article with Outstanding Investments predicting $140 oil.

Trying to time the change in a multi-year trend line is risky, especially one that's hitting a new 52 week high seemingly every week.

Full Disclosure: No positions