Oil is Back to Puking

One of my last trades of 2014 was XLE, and Oil and Natural Gas stock ETF. I got into it to test a new trading pattern, but the fundamentals and overall bear mauling in crude oil offset that.

It looked like oil tried to form a bottom, but it was a pitiful attempt. The selling returned this morning after Friday and Weekend reports of Russia and other OPEC nations still not only refusing to cut production... but now they're ramping it up.

This makes perfect sense... for them. Russia is facing a full blown currency crisis and needs every cent of revenue they can get their hands on. Even in the face of crashing oil prices, they must sell to take in revenue even if it means they take big losses. Think about it: if you took big pay cut at your job (and you cant switch jobs), and you have to pay rent, are you going to quit your job? That wouldn't make any sense.

I'm no expert on the oil market but I really do think this down move is severely overblown. Traders are expecting deflation in Europe and Japan, rising rates in the US and a stronger dollar, and an oversupply and falling demand for oil. Add that all up and you get a panic sell off.

But it's unusual... why so sudden? The supply>demand issue should have meant that oil would gradually come down, not fall off a cliff. The idea that rates will rise in the US isn't new either, and as I've said before, that isn't going to happen. Deflation expectations have been around in Europe for what, years now? Same for Japan.

It's a little perplexing to say the least. But now matter how wrong the stampede may be, you don't stand in front of it. Period. You can't talk sense to a mob.

I think though, that once traders realize that the Fed isn't going to raise rates, that long oil will be a wildly profitable trade. That said, it would be better done in pure commodity options rather than an ETF or stock option play. Some companies may not survive long enough to see the day, because nobody can know when the traders will wake up; it could take all year, who knows?

Just as a visual, the following charts are crude oil and the US dollar (as compared to a basket of currencies)

The two are almost perfectly negatively correlated since about July... so most of this down move in oil is due to the mistaken notion that the Fed is going to raise interest rates, making the dollar stronger. Markets are somewhat self-fulfilling prophecies.