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Crude Oil Hurst Cycles


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#41 SilentOne

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Posted 18 February 2009 - 10:03 PM

Well, same old, same old. The insanity of last summer is now occuring on the downside for oil. They want to drive crude right back into the ground. At some point soon, everybody will realize that the world has already run out of $35, and $40 oil. I expect that might just happen within the next 6-7 days. But at what price will crude be? <_<

crudeFeb18200911weekon.png


I bought a little USO yesterday. Call it a starter position. Then someone pointed out this article to me today. Whatever.

I am sure that someone out there has shorted USO to oblivion here and went long something else to counter it. Well that trade won't cut it in about week's time.

cheers,

john


Don't Buy USO (Buy USL Instead)

Don't Buy USO (Buy USL Instead)
Written by Matthew Hougan
Monday, 09 February 2009 07:59
Investors are pouring money into the United States Oil Fund right now. They must be out of their minds.

I have nothing against people wanting to buy oil at $40/barrel. That's a cheap price, and there's reason to believe that spot crude may rise over the next six-to-twelve months. OPEC appears to be sticking by its production cuts, overall supply is down and it feels like the global economy may be leveling off. Oil could easily go to $50/barrel, which would be a 25% jump from here. Where else in today's market are you going to get that kind of return?

But if you want to profit from that rise, USO isn't the way to do it.

This is a big deal. According to the Wall Street Journal, investors poured $3.46 billion in new money into the U.S. Oil Fund (NYSE Arca: USO) in December and January. That makes my hair stand on end, because those investors have gotten crushed. And if things stay the way they are today, they're going to continue to get crushed.

The reason, as I've written about time and time again, is contango. The oil market is in violent contango right now. All else being equal, any strategy that focuses on buying the front-month futures contract and rolling it forward is going to lose money. A lot of money.

This is simple mathematics, and it pains me that people are missing the story.

Here are the current prices for oil contracts with expirations in the next six months. Notice how every contract is more expensive than the one that preceded it. USO follows a simple strategy of buying the current contract and then rolling into the next contract before the current one expires.

March 2009
$40.42

April 2009
$46.22

May 2009
$48.88

June 2009
$50.45

July 2009
$51.28

August 2009
$52.70

Source: NYMEX. Data as of 2/9/08.

Until last Friday, USO owned the March 2009 contract. Specifically, it owned 84,378 March contracts, entitling it to 84.4 million barrels of oil.

But on Friday, it sold all those contracts and bought the April contract instead. But because the April contract cost $6/barrel more than the March contract, it couldn't afford as many contracts. In fact, if you exclude new inflows into the fund, it could only buy 73,444 April contracts.

Whammo presto, the holders of USO lost 13.4% of their exposure to crude oil. They now control less oil. If the spot price stays near $40/barrel, the value of those April contracts will decay back to $40/barrel over the next month and investors will lose their shirts. If the price of oil jumps 15% in the next month—before USO rolls again into the May contract—investors will only break even.

This contango effect killed oil investors in January, according to Standard and Poor's, which runs the most important commodity index in the world.

"The steep contango in the WTI crude oil futures market (when further-out futures trade at a premium) was the primary factor causing the S&P GSCI Crude Oil Index to decline 18.90% in January. The spot price of crude oil dropped 6.55% on the month, but rolling from the February to the March future contacts accounted for most of the remaining 12.35% of the decline in the component index."

Got it? Contango cost you 12% in January. And it's worse now.

What's so horrible about watching people plow their money into an investment that they don't understand is that there are so many nice, viable alternatives out there.

The same company that offers USO offers a great little fund called the U.S. 12-Month Oil Fund (NYSE Arca: USL). Rather than simply holding the near-month futures contract, USL holds equal positions in each of the next 12 months' worth of futures contracts. Spreading out its bets like that helps minimize contango, which tends to be worse in the near-month contract, and gives you more direct exposure to the spot price of crude.

Not surprisingly, over the past three months, USL has outperformed USO by 13%.


Edited by SilentOne, 18 February 2009 - 10:07 PM.

"By the Law of Periodical Repetition, everything which has happened once must happen again and again and again-and not capriciously, but at regular periods, and each thing in its own period, not another's, and each obeying its own law ..." - Mark Twain

#42 Lysis

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Posted 19 February 2009 - 12:18 AM

John, I'm probably going to wait until I see a positive day. It might be tomorrow and if so, I'm buying for a three to five day bounce at the close.

#43 gismeu

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Posted 19 February 2009 - 12:22 AM

Hi SilentOne, thanks for the update. When looking at your chart it looks like the 14 day cycle is at its peak whilst the other two bigger cycles are still in a downtrend. That is how your chart looks to me, so I wonder what made you bullish now? You could have waited another week or so for the 14 day cycle to bottom, couldn't you? Many thanks, gis
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#44 SilentOne

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Posted 19 February 2009 - 09:49 AM

hello gismeu,

You could have waited another week or so for the 14 day cycle to bottom, couldn't you?


Yes, that is what I figure. My initial entry here into USO is the idea that I will buy some $35 oil for starters. I will buy a lot more next week. There are large cycles at play here now so the smaller cycles may be thrown off. My next buy will be $20 for USO and USL and I will accumulate some energy names later this week.

cheers,

john
"By the Law of Periodical Repetition, everything which has happened once must happen again and again and again-and not capriciously, but at regular periods, and each thing in its own period, not another's, and each obeying its own law ..." - Mark Twain

#45 darnelds

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Posted 19 February 2009 - 12:57 PM

Thanks for posting the difference between USO and USL. Any idea how they compare with DXO (other than the obvious that DXO is leveraged 2 times)?

#46 gismeu

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Posted 24 February 2009 - 12:25 PM

Hi, anybody here having a view or trading UCO (Ultra DJ-AIG Crude Oil ProShares)? What caught my interest is that it has options and is trading at around $6, not like USO at 23 Thanks, gis
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#47 inamosa

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Posted 25 February 2009 - 06:47 PM

Keep up the great work SilentOne

Long on USL since yesterday

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#48 SilentOne

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Posted 26 February 2009 - 12:23 PM

hi alysomji,

Long on USL since yesterday


Yes, we have a rally here in USO and USL now in its 6th day. I added USL yesterday as well. The 14 day cycle appears to have already bottomed, but we'll have to see what the next few days gives us. If you look at USO, it has not rallied for more than 7-8 days since July 2008. If USO can rally for more than 7-8 days, and preferable at least 10 consecutive days, and then find a low into its 14 day cycle low, this would be very bullish. This differs with crude light sweet futures which has already rallied more than 7 days (max. rally has been 8 days since last summer), so crude futures is acting well so far.

I also have a new FLD target generated based on Tuesday's close which targets just under 30 for USO. This is the first target for this 14 day cycle.

March 6th is an important turn date and now we watch and wait.

cheers,

john

Edited by SilentOne, 26 February 2009 - 12:33 PM.

"By the Law of Periodical Repetition, everything which has happened once must happen again and again and again-and not capriciously, but at regular periods, and each thing in its own period, not another's, and each obeying its own law ..." - Mark Twain