Oil Markets: A Speculator's Paradise

The hallmark of a bull market is its ability to defy what are accepted normal patterns of behavior. The Internet bubble, and other similar periods of frenzy are proof of that tenet. Nevertheless, all speculative frenzies end. And they all end badly.

The oil market at the current time, is a speculative frenzy. Yes, there is danger of supply disruption. And yes, the war in Iraq is a major uncertainty. And most definitely, if there is a cold winter ahead, prices should remain way above normal.

But, those factors do not change the fact that when the bubble bursts, the oil market will fall, just like other bubble markets have.

According to the Wall Street Journal: "Oil has become a speculator's paradise. Surging energy prices have attracted a horde of investors -- and their feverish betting on rising prices has itself contributed to the climb. These investors have driven up volume on commodities' exchanges and prompted a large push among Wall Street banks and brokerage firms and many European banks to beef up energy-trading capabilities. As the action has picked up in the past year, those profiting include large, well-known hedge funds, an emerging group of high-rollers, as well as descendants of once-highflying energy-trading shops such as Enron Corp."

The Journal also reported that "Oil-industry veteran Boone Pickens runs two hedge funds that are among the biggest players in oil and natural gas, and have scored gains of more than $550 million in the past two years. Giant hedge funds, including Paul Tudor Jones's $9 billion Tudor Investment Corp. and D.E. Shaw & Co., an $8 billion firm, also have scored big gains."

According to the report, some hedge funds are now using 10 to 1 leverage on their position, meaning that they "borrow $10 for every $1 of money they invest in some trades. Mr. Pickens is considered to be among the players using the most leverage in the market."

For now, the technicals in the futures suggest that indeed there is support for oil above $45 per barrel. And the renewed strength in oil stocks, suggests that the party is not over. A recent report from Morgan Stanley, courtesy of a subscriber, suggests that with the oil markets, the commodity can lead the stocks, contrary to the more traditional view of the markets. For now that seems to be holding up. Although, as experienced traders know, when the prevailing view is that "this time it's different," the end is often near.

No one knows when the top in the oil market will come. But, current evidence suggests that it's got to be closer than most think.

The Philadelphia Oil Service Index (OSX) recovered last week, but did not make a new high. A strong close above 112-115 would likely signal a new rally here. A break below 98 its 200 day moving average, could send it plummeting to the 88 area in a hurry. For more details on trading the energy sector visit our energy timing page, featuring our highly effective OIH timing model and our Top Ten Energy Stock List.

The Amex Oil Index (XOI) recovered but remained below the 630 area. . The 610-627 area is key support, and has been penetrated. This is still a crucial juncture for the entire oil sector, as a continued failure in the near term could lead to a major top forming. A close below 600 would be a very negative technical development. For immediate analysis, including stock picks, and the latest in technical analysis of the entire energy complex, our subscriber section has a full complement of recommendations in oil service and the rest of the energy complex.

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