Expect to win and you will win more. When you don't expect to win you will lose more.

- Michael Levin

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July 17, 2007

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I’m not going to say that oil prices are headed down to $30 a barrel or anything crazy like that. We all know that the demand for petroleum based products has gotten to the point where we are “certain” that the prices we have paid in the past will remain in the past.

Just like when I was a kid and I paid 50 cents to see a movie and 25 cents for the candy I enjoyed, the same will be said for oil prices in the next 5-10 years. Old timers will say the usual “Oh I remember when my father used to pay $.299 for gas” and then that will move to the 30-40 year old set when they will say “Oh I remember paying $1.299 back in the day”…

I am talking as a trader when I say that I honestly expect not only a pullback here in the price of crude, but a sharp selloff to boot.

I’ll start off by showing you how great things have been since March; looks fantastic in many ways:

If you cannot view the Current Oil Chart, go here.

OK, now see where it’s been for the past few years on a weekly basis:

If you cannot view the 2-Year Oil Chart, go here.

Hmmmm, can you say: “Double Top”?

Heck, that was a nice selloff at the end of last year, maybe even coinciding with where we are now, time wise…

Now here is the picture from the past 10 years:

To view the 10-Year Oil Chart, go here.

The recent run-up doesn’t show on this chart, my apologies, but suffice to say, a tripling of these prices over the past 3-4 years has been great for the countries that pump it out of the ground and these 10 countries are the ones driving demand:

United States …        21 million barrels per day (up 18.6% from 1994)
China …                     7 mbpd (up 118.8%)
Japan …                  5.4 mbpd (down 6.9%)
India …                    2.7 mbpd (up 92.9%)
Russia …                 2.7 mbpd (down 18.2%)
Germany …              2.5 mbpd (down 13.8%)
Canada …                2.3 mbpd (up 21.1%)
South Korea …         2.2 mbpd (up 22.2%)
Brazil …                  2.2 mbpd (up 57.1%)
Mexico …                2.1 mbpd (up 50%)

I am putting aside some of the actual logic involved in choosing Oil as a bullish play in this article and just looking at the “trade” here and that I have found over the years that when I poll the traders, associates and even lay investors, that when everyone seems to be on the same side, with the same reasoning, the same conviction and the desire to re-accumulate or average down if prices move against them... That something is about to change.

Here are a few examples to show you, though they are not exactly correlative to Oil, it does show what I am talking about:

1^st up and most recently is Corn.

Why do I bring up Corn? Because everyone and their mother were so convinced that Corn was going to the moon because of the Ethanol explosion and the price of oil skyrocketing enough to make ethanol price competitive.

Look at this chart of Corn. Since MARCH it has already had 2 nice pullbacks, the last one a precipitous drop:

If you cannot view the Current Corn Chart, go here.

Corn took more than a 22% tumble in how many days? Less than 11 trading days!

To be fair, it did have a great run-up at the end of 2006:

To view the 2-Year Corn Chart, go here.

I once heard a great quote from an old trader that seemingly was always at the right place at the right time. I am rephrasing it a bit as I don’t remember every word he said, but it went something like this:

“Some things are over owned and over known, stay away... Other things even things as plain as day, are under owned and under known… walk in and take a position”

Insofar as Oil and Corn are not even in the same ballpark they do have a similar quality to what that quote gets to the heart of. That once the crowd has all the same info and is decidedly on the same side of the trade, then you almost HAVE TO BE in the opposite camp.

But this time it’s different! Oil is in a worldwide demand explosion, with China and India growing like crazy and needing more and more of it. Yea, I know, EVERYone knows that… What else ya got?

Oh, that Oil reserves are limited and the threat of terrorism to disrupt oil supplies is so prevalent, we must stockpile oil now for our use in the future? Yea, heard that too. Terrorism of many kinds has always been around in order to prop up prices of many things, from Gold to Copper to Oil to Currencies for years and years. In fact, usually when something of that nature occurs, it is a SELL signal, not a buying one.

Take the Nigerians that always threaten some sort of strike causing oil to spike higher, what happens next? Ohhhh, they decide not to go on strike… how interesting.

It is not unusual to see 25% pullbacks in commodity pricing, come on now.

Look at the following commodities over the past 18 months:

Coffee              Two 25% pullbacks
Lumber            30% pullback
Copper             35% pullback after steep run-up          
Gold                20% pullback after steep run-up
Silver               33% pullback after steep run-up
Cattle              25% pullback
Hogs               22% pullback
OIL                 30% pullback less than a year ago

Ohhhh, so Oil already has had a huge pullback, less than a year ago? Did all this demand from China and India arrive suddenly? NO... What about the war in Iraq? Been around for YEARS already... Terrorism? How about hurricanes and other weather related events?

Do you see what I am driving at? Everyone is HOPING for these things to drive prices higher so they can sell to someone else!

What if we have another light hurricane season? What if it gets to October and it’s still warm outside? What if the countries that are exporting Oil start getting greedy and want to get more $ and pump out more Oil?

What then my bulls? It’s called a stampede for the exit…

I’ll give you one last chart from years gone by... It was called the Nasdaq:

If you cannot view the 10-Year Nasdaq Chart, go here.

We all know that when everyone gets caught up in something and everyone is either taking or talking the same side of the trade, then the trade is long in the tooth and that better trades are getting ready elsewhere.

Will Oil come back to $50 a barrel or even $40 a barrel? Wouldn’t that be great, but because of how hooked the world is on Oil and the products that come from Oil it probably won’t... But how much upside is there at these prices given how inherently bullish everyone seems to be?

In conclusion here, I am saying that I expect prices to hover up here for a short while, but I don’t see a catalyst to drive anything higher of any significance.

I DO see things that could make this market cascade lower and actually at any moment.

If anything aside from buying puts or outright shorting, at least do some bear spreads to take advantage of what I believe is a coming cascade down in Oil prices…

All the best in your trading and no matter what, pick your stop point and get out when you are wrong.

Michael Levin is a Consultant to Platinum Trading Solutions. He has been in the Financial markets since 1981, having been a broker and trader on the PHLX Equity Options floor in the 1980's and ran trading firms in New York in the 1990's to 2002. Mike briefly set a record in the options trading division of the US trading Championships years ago.

Trade the Platinum Commodity Spread Program COMPLIMENTARY for 60 days

PLUS, for a limited-time only, receive 30-days complimentary access to the Platinum Weekly email market performance update! This system works! Long only commodity funds that buy and hold huge quantities of futures contracts in many commodities have become a very powerful force in the market. These funds act in a very predictable way and the Platinum Commodity Spread Program has found an ingenious way to profit from the price movements of the spreads caused by these long-only funds. The Commodity Spread Program is now offered on a limited basis by Platinum Trading Solutions. Go here to learn more.