One of my favorite types of trades presented itself this week so I thought I would write about it and a future opportunity that may be arising in the next couple of week. This trade came from Goldman Sachs lowering the price target on oil to $105/barrel, arguing that the fundamentals do not support oil at this price and claiming they were unwinding some of their long positions in the energy trade.
Now there are several things wrong with this picture in my eyes.
1) How credible is a Goldman Sachs report: Please remember this is a firm that made billions betting against their clients. Their job, their only job, is to make money and with an ever increasing amount of that money coming from prop trading it is not unthinkable that this pillar of ethical integrity might, just might, seek to manipulate price to offer a good entry point into a trade.
2) What do fundamentals have to do with this trade: If the trend is up, the trend is up. Furthermore, those betting on oil coming down on the news of calm in the middle east have another thing coming, as this will continue to be a problem for several years if not longer.
3) Oil is priced in US dollars: When the dollar declines in value, the price of things measured in US dollars – commodities and energy – goes up even in the absence of net buying.
On the back of this, I loaded up on the ETF USO (via buying calls – implied volatility generally rises during earnings season but this is for another time) on this decline in oil, adding to the position 4 separate times. The charts seem to support the trade thesis, and I view oil above $115 on a weekly closing basis the point of no return, and should we see that expect to see a run up to at least $145/barrel. This is the chart I have been trading off of, I have made extensive notes.
I expect, on the back of a Goldman Sachs downgrade of copper, to see Goldman downgrading gold and silver as well. I certainly expect these commodities – especially silver – to be much more resistant to this but will nevertheless be stalking for a good entry point on the back of any such downgrades. The reasoning for this is simple, gold and silver are both in monstrous uptrends – silver has basically gone parabolic – as I predicted here. I am much more interested in gold, its not that I don’t think silver won’t go higher, I just won’t buy something so extended unless it has a meaningful pullback.
Another bit of food for thought is that the precious metals are still an underweight component of many many institutions that manage ungodly amounts of money (pension funds, sovereign wealth funds… etc), and while this may not change, if it does…
And finally, speaking of points of no return, it may be prudent to take a look at the US dollar, as this is the macro driver behind many of these trends. OPEC is also a factor for the energy trade, but honestly they are probably more concerned with not being roasted alive by their citizens and likely will not take drastic steps to prevent an increase in oil over the short term.
Several factors are important to consider with the dollar:
1) The spending of the federal government is now largely funded by Fed purchases of treasuries as foreign buyers step away. How can you stop printing when you need to do it just to run your government?
2) 2012 is an election year, and the economy is still shit in America. Once QE2 expires, I fully expect some other government support of the markets to be put into place (repatriation of corporate earnings, QE3, or some other mechanism). I expect this to be heralded by cries of deflation from sell side economists which have already been kicked off by the leader of the market manipulation pack.
3) Further strength in the Yen could easily lead to more intervention in the forex market. This would be bullish for the dollar, but in my eyes short lived.
4) Raising interest rates would indeed reduce the expectation of inflation but would also massively increase the borrowing costs of the government of the United States – which increasingly looks to the short end of the curve for its funding. Therefore I view this as a lot of talk and posturing on the part of the Fed, since we have seen firsthand that countries can have 0% interest rates for decades.
5) As long as the US dollar is the worlds reserve currency there will not be any form of meaningful pressure on the Fed to stop printing money, and the argument that it is simply to readdress the imbalances with China will still have some semblance of credibility (even though it is a farce, as America has been debasing the dollar since Nixon took them off the gold standard).
This is all, of course, my opinion.
Full disclosure: I am long GLD, USO, and several miners/refiners.