Anyone observing the market action in stocks, commodities or currencies over the past month knows that these are not “normal” times in the markets. First we get the whole “QE2” story, pressuring the US dollar and causing a surge in asset prices. Then we get Chinese rate tightening and the reemergence of European debt fears. This brought foreign interest back to the dollar, driving asset prices back down. Then prices rebound again as traders deem the sell off “overdone.” At the risk of using trader jargon, the past 30 days have been all about the “macro.” In other words, global economic events (such as those mentioned above) have temporarily taken a leadership role in the factors influencing price direction of the commodities markets as a whole.

In the short term, these factors cannot be underestimated. Our opinion here at Liberty trading is that the prospect of an EU/IMF bailout of Ireland will reassure the global market, allowing the US dollar to eventually resume it’s focus on QE2, and thus, a calmer yet persistent downtrend. This should help lend eventual support to commodities and thus, energies as a whole over the longer term

That being said, the only thing certain about macro-economic forecasting over the past 12 months has been uncertainty. To identify more consistent trading opportunities, one must look for something more consistent on which to identify an investment opportunity.

The Demand Factor

Despite what happens with the EU, China or the US money printing plan, natural demand cycles for certain commodities tend to remain constant. For example, at some point during the dead of winter, usually in January or February, refineries reach a level where heating oil inventories are deemed adequate to meet winter heating needs and begin to scale back heating oil production in order to ramp up production of gasoline. This “switch over” can take a few weeks and refineries often shut down during this time period to make necessary adjustments and do annual maintenance. This in itself can cut back supply of both heating oil and unleaded gasoline in the short term.

Distributors, however, have already begun anticipating summer gasoline demand needs and typically begin accumulating inventories as early as December. This sparks demand for unleaded gasoline on the wholesale level that gradually builds to a crescendo in mid-summer.

This can often (but not always) result in strengthening unleaded gasoline prices as a result of building demand.

Chart 1


Regardless of conditions in the overall economy, gasoline demand tends to begin rising early in the year and peak in late summer at the height of driving season. (Chart Courtesy Hightower Research. Past performance is not indicative of future results).

Trade Strategy

Does building gasoline demand or a weakening dollar automatically guarantee rising gasoline prices? No. What rising demand does is provide a backdrop – a context if you will, in which to view macro developments. Think of seasonal demand in gasoline as a drummer in a rock band. He doesn’t get the attention like the singer or the guitar player. But he sets the tempo to which the other players play.

Gasoline could also benefit from what is a begrudging and uneven economic recovery in the US. Average total gasoline demand for the last 4 weeks is up 1.81% compared to last year. AAA expects Thanksgiving travel this year to increase over 11% from last year. Meanwhile, the latest EIA figures show gasoline inventories are down 1.4 million barrels from this time last year to their lowest levels since August of 2009.

If the macro fireworks are behind us and markets are indeed stabilizing, the focus will return once again to core fundamentals in the energy complex. In our opinion, this would be a bullish development for unleaded gasoline as well as the rest of the petroleum complex.

At the very least, rising wholesale demand should be a bullish force that spurs rallies and hinders sell offs, if macro headlines are not yet finished “singing.”

For this reason, we at Liberty Trading continue to like put sales in the April and May reformulated blend gasoline (RBOB) contract. Like many commodities now, the recent volatility has made very deep out of the money strikes available for astute sellers of options. We advise taking advantage of the premiums while they last.

Chart 2: May 2010 Unleaded [RBOB] Gasoline 19 Nov 2010




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