August 18, 2009
The relative price strength in equities and commodities got a bucket of cold water thrown on it last week. A plethora of economic data seemed to indicate that the rosy forecasts put forth by many are not quite coming to fruition yet. In fact, it seems to suggest what we have been arguing all along; this "recovery" is based on smoke and mirrors.
A real recovery will require improvement in two major areas: Consumer spending and Housing. Sure, you can buy Saks because losses "were not as severe" as expected. But just because equities have rallied as of late does not mean that economic recovery is around the corner. Sooner or later, consumers are going to have to start buying the things these companies are producing.
As home equity was a key ingredient in the massive spending habits of the American consumer, the deflation of US housing values has not only removed the single greatest engine for spending, it has struck fear into the US consumer. The asset devaluation of the last 12-24 months has shifted consumer focus from spending to saving and paying down debt. The result has been punishing to US retailers.
US retail sales are down a whopping 8.3% from this time last year and a full 10% since their peak in 2007.
Until this trend begins to reverse, an abrupt turnaround in the US economy is unlikely. With a full 32% of US homeowners now underwater on their mortgages, do not expect this to occur any time soon.
Investors dependant on asset appreciation may want to proceed with caution, at least until the rallies of late can cite something other than hope as their primary basis.
For option sellers, however, these can be opportune times. Prices moving in defiance of supply/demand fundamentals can create inflated premiums for deep out of the money options - at prices unlikely to be obtained without a fundamental justification.
In June, we at Liberty Trading recommended in this advisory to sell crude oil calls. As those premiums have largely decayed at this point, investors who took advantage of this trade may now want to consider going back to the well again.
Crude oil is a market that has been moving in the opposite direction of its underlying fundamentals. Speculative buying, hope for a brighter economy and driving season (increased demand for gasoline) have all contributed to higher prices this summer.
Yet, supplies remain near 20-year highs, global demand remains off as a result of continued economic recession and we are heading into what is known as "shoulder" season: a time of year between consumption cycles when demand tends to slack. By the Autumn months, the peak demand season for gasoline (summer) is over, and the peak demand season for heating oil (winter) has not yet begun.
Chart 1
Chart courtesy of Hightower Research
As these are the two primary products produced from crude oil, demand typically falls and crude oil stockpiles tend to accumulate. Combined with the economic observations made earlier and oil's reluctance to trade much over $70 per barrel for any period of time, oil prices could be at or near a peak for the year. This can be a good opportunity to profit from falling oil prices.
It is true that demand from China and India remains crisp, at least for now. But the US still remains the world's largest consumer by far and it seems difficult to suggest that prices can mount any type of sustained bull market without US participation in some type of recovery.
Chart 2
Chart courtesy of Hightower Research
We provided our price forecasts for crude oil during live appearances on Fox, Bloomberg and CNBC last week.
(To watch James Cordier's live appearance on Fox Business from August 14th, 2009, click on the following link http://www.libertytradinggroup.com/news.html )
However, option sellers don't make their money on where prices go. They make their money based on where prices do not go. Recent price strength has made premiums available in crude oil calls at strikes nearly double the current price of crude. We are now recommending a series of these strikes to our investors as high probability option selling opportunities. If you are selling premium on your own, now may be a good time to consider adding crude calls to your portfolio. Limited rallies should be good opportunities for positioning.
Chart 3: Crude Oil Chart, Dec 09; Aug 18, 2009
At least until we all start driving to the mall again.
Note: The opinions presented here are that of Liberty Trading and not necessarily shared by Optionetics and/or its instructors.
James Cordier & Michael Gross
Contributing Writers, Liberty Trading Group/Optionsellers.com
Optionetics.com ~ Your Options Education Site
