A Great Short Sale Is Setting Up in Oil...
By Jeff Clark
March 06 , 2008
It finally happened.
Yesterday, oil broke out decisively and held above $100 per barrel. Oil bulls have been waiting a long time for this day, and they'll tell you it's the beginning of another leg higher.
And they're right. Well, sort of. Oil is headed higher over the short term. But it won't be the start of another massive move higher for the great oil bull market. Instead, it will be the final, speculative, blow-off stage that always seems to occur just before a major correction.
Let's not fight over the fundamentals for oil. Both the bulls and the bears make compelling arguments. The bulls talk about peak oil, increasing demand from China and India, and the unwillingness of OPEC to increase supply. Oil bears point to the looming economic recession, the swollen inventory levels, and the emergence of alternative energy sources.
I can't decide who's right. Fortunately, I don't have to. The charts tell the story.
Take a look at this chart of crude oil...
For the past several months, the price of oil has been stuck in a trading range between $88 and $99. When a chart breaks out of this type of "horizontal rectangle" pattern, the gains should be roughly equal to the height of the rectangle itself. In this instance, the rectangle measures about $11. So yesterday's breakout projects a move to about $110 per barrel ($99 plus $11).
Aggressive traders can try to take advantage of this move by purchasing shares in U.S. Oil Fund (USO). Here's the chart...
You can see the same horizontal rectangle formation and the same breakout pattern. This chart projects a move up to about $87 per share for USO.
The real money, however, will be made shorting oil when it gets to $110.
Go back and take another look at those charts. Crude oil gained just about 100% last year. Moves like that almost never repeat. More importantly, though, the strength in crude is not reflected in the oil stocks.
Oil is breaking out to all-time high prices, yet the AMEX Oil Index (XOI) is nearly 10% below the high it reached in December. When it comes to commodities, stock prices are leading indicators. Oil stocks rally before the price of oil goes up. And oil stocks fall before crude oil declines.
The underperformance of oil stocks is telling us there's a really good short-selling opportunity setting up with the price of oil.
It's not there yet. But it's close.
Best regards and good trading,
Jeff Clark
