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Oil Top Sets up Next (Last?) Market Leg Up

Posted By Barry Ritholtz On March 17, 2005 @ 2:14 pm In Commodities,Markets,Trading | Comments Disabled

As of this morning, our expectations of $57 a barrel [1] have
been met – and exceeded. This has very significant consequences for how the
markets will behave in the near future. We have considered numerous theoretical
possibilities; The following scenario is in, our opinion, the highest
probability:

Oil makes an intermediate top in the $57 to 59 area. The
pullback from this level allows markets to rally.

When oil once again finds its
footing – (our guesstimate is $48-51) and heads higher again, that sets up a double top in the major indices.

It is possible (though far from definitive) that this could
even mark the high point for equities in 2005. Regardless, as Oil rallies back towards its
prior highs, stocks run out of energy, and start heading back towards August
2004 levels.

We find it ironic that oil doubters — the ones who were so harshly negative
when Crude was between $40 and $45 — have suddenly found religon. We recall hearing about the $20 "terror premium," the
$15 bumb that speculators were causing. We wereb even warned that the Chinese economy was
slowing (that implied lower oil also).

Indeed, we had heard every "excuse" for the price of oil -
except for the one that mattered: A
gradually improving global economy, one that was concentrated in Asia but particularly in
China and India. We would be remiss if we failed to note that over half of the
vehicles in our neighborhood are gas-guzzling SUVs. To be fair, we must
acknowledge our own tendencies towards high HP vehicles and inefficient driving
styles; At least we are inclined towards the more fuel-efficient manual
transmissions (6 speeds preferably).

As oil passed $50 on the way to $55, something intriguing
occurred: The Oil Bears became rip roaring Bulls. We now enter what we
academically refer to as “the stupid phase,” with calls for $100 crude and
unsustainable gains in the energy sector.

Oil has become a crowded trade, with Speculators shifting to
net long crude futures
and options
, as opposed to a more recent position of close to "net flat."

As someone who has been bullish on Oil since December 2003 [2], we are
comfortable stating our expectations of an intermediate oil top between $57
-59. We expect the market’s response to any pullback from those levels to be
positive, but short lived.

As we have previously stated, use this opportunity
to reduce margin and, where appropriate, marry puts to long positions.


Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2005/03/oil-top-sets-up-next-last-market-leg-up/

URLs in this post:

[1] expectations of $57 a barrel: http://bigpicture.typepad.com/comments/2004/09/oil_50_a_barrel.html

[2] December 2003: http://www.businessweek.com/magazine/content/03_52/b3864629.htm

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