The profit taking I expected last week failed to appear and oil prices hit a new record at $75 on Friday afternoon. I warned last week that the June contract appeared ready to breakout and was showing much more conviction than the expiring May version. Neither showed the slightest bit of weakness until Wednesday and it was only temporary.
The conversion from May to June occurred on Friday and traders moving from May sent June to the moon. Option expiration also exerted an upward bias and the $75 target was clearly in the cross hairs. One trader in the pit said after the close on Friday that traders were dumbfounded. He said sell orders were nonexistent and only after $75 was touched did the momentum ease. When asked about the new target for oil in 2006 he calmly said $100 much to the dismay of the interviewer. He also felt we should see a pullback but only a brief dip and then a retest of $75. If $75 is broken again on volume then the sky is the limit. He said shorts were feeling the pain but felt $75 was the line in the sand that would not be crossed. Once crossed on volume massive short covering would appear. The strangest fact of this entire scenario is that oil inventories in the US are at eight-year highs. Something has got to break soon.
Oil and gasoline inventories this week will be critical. Should we see another major decline in gasoline levels like the -5.4 million barrel drop we saw last week all hell will break lose. However, a positive build should knock the props out from under oil prices.
The Baker Hughes rig count for the week fell -19 rigs to 1591 of which 1331 are drilling for natural gas. Only 259 are hunting for oil. The demand for gas is growing rapidly and the payback on a gas well is much faster. Gas wells typically have a 3-5 year life. The gas injection season for the winter of 2006 officially started last week. I know it sounds strange with snow still falling in some parts of the US but that is the way the calendar stacks up. The season began with the highest levels of gas in storage in 15 years. +47 BCF of gas was added to storage last week bringing the level to 1,761 bcf and +63.7% above the five year average. Considering the current glut of gas it is amazing that prices shot up to more than $8.20 last week, $11.77 for the December contract. Gas producers must be out of their minds with joy given the large numbers. Chesapeake, Encana, Chevron, Conoco, EOG and Ultra Petroleum have got to be selling into those winter numbers on a daily basis. Profits are going to be huge unless they wee already hedged against a fall earlier in the year.
With Chinese President Hu Jintao in the US this week the focus was on growth in China and growth in oil demand. China consumes 6.6 mbpd of which 2.9 mbpd are imported. China has 18.3 billion bbls of proven reserves and an estimated 35 billion bbls of undiscovered or unproven reserves. That is obviously a highly doubtful number. In 1996 China consumed 3.4 mbpd or roughly half of today's consumption. In 1996 China only imported 400,000 bpd compared to the 2.9 mbpd they import now. This was a +625% increase over the last ten years. They doubled in only the last four years. With China's current growth rate at over +10% the Chinese government officially expects total oil demand to grow by +4% per year through 2020. I said "officially." It is obvious to anyone looking at the numbers that only 4% would be anemic. China has 1.3 billion people but only 26 million cars. That is less than the total cars in California. (28,146,424 as of 2000) They also have less than 5500 miles of highway compared to 168,075 miles in California. 17 years ago China had NO highways. China is rapidly constructing 55,000 miles of interstate type highways linking all the major provinces by 2012 as well as thousands of miles of infrastructure roads. By 2020 they expect to double the total mileage of available highways. As these roads are completed auto use will accelerate as will auto ownership and gasoline consumption. China saw sales of five million autos in 2004 and an estimated six million in 2005. It would have been more but China halted the +75% per year jump in auto sales they had in 2003 by putting strict rules in place on financing and ownership. Still auto sales are expected to grow by +15% a year or more for the next decade. Only 8 of every 1000 people own a car. It will not be long before the lure of a "dream machine" pushes that ownership number much higher despite the restrictions. 1.3 billion people are yearning for a better life and we in America know how cars provide that dream.
I get a kick out of people who claim oil usage will not increase. With approximately 35 million cars and trucks produced annually around the world it is impossible for demand to slow. Once China and India really catch the automotive fire that number could jump to 50 million. The only thing that will slow automotive growth is the lack of oil and that is coming at us very fast.
The Secretary General of OPEC said on Thursday there was little they could do to dampen high oil prices. He finally admitted what we have known for years. OPEC cannot pump any more light sweet crude. In fact their production volumes have fallen due to the problems in Nigeria. They have plenty of sour crude with about 1.5 mbpd of excess production but not enough light crude to satisfy demand. The Iranian Oil Minister Kazem Vaziri Hamaneh said OPEC is pumping crude at their limits but demand was outstripping supply. Both of these comments were very out of context with the party line and showed their frustration with the current state of the oil sector. OPEC is meeting in Qatar this weekend but will not be discussing quotas. There is no need since they can't produce any more than they are currently producing and they are swimming in petrodollars despite full production.
Earnings are beginning to appear and so far they have been in blowout proportions. Peabody Energy beat estimates Monday and soared +13 before Friday's close. Arch Coal jumped nearly $10 on the BTU results but then another $10 on Friday after they released their guidance. Coal is the new black gold and there seems to be no end in sight.
After the jump in crude prices on Tuesday I sent out an update suggesting some new covered calls on the assumption that a pause was just ahead. Obviously that did not happen with the contract switch and option expiration keeping the pressure on prices. On Friday during the day I sent out another update when oil hit $75 and recommended some short term puts on the IYE, the Dow Jones Energy iShare. Those puts were not an official portfolio position but simply a hedge against a possible drop. I will not be adding them to the portfolio. I firmly believe we will see some profit taking but I believe the dip should be bought. However, we need to be careful about buying a dip once gasoline inventories begin to build. That could be dangerous. We are still not in the official driving season so a buildup should occur before the Memorial Day kickoff. Once that buildup begins it could get ugly fast. We have so much profit built up in many positions that I am going to raise some stops to take us out once a major dip occurs. We will look to reenter those positions using longer-term options.
I received numerous emails over the last couple of weeks asking how to enter the plays if they missed it the first time around. New readers or readers that were invested elsewhere when the first recommendation was made are always asking how to enter. This is the $64 question!
Oil prices tend to cycle about once a week when they are trending. This gives us a one to two day window each week where the individual stocks retreat on a dip in oil prices. If the stock you are targeting has not run away from the initial entry point then this weekly dip should provide a decent entry. If the stock is like BTU or VLO then you may need to wait for the real dip that occurs once or twice a month. Things like contract changes, option expiration, end of month rebalancing or just simple profit taking will eventually knock the entire sector back to real support. This normally happens at least once a month.
When I want to leg into a position I will watch for trending support levels on the chart and try to target an entry about a buck above support. Using Valero as an example this weekend I would really like to buy a dip to the 100-day average on a daily chart. However, I have exactly two chances of that happening, slim and none. VLO has used the 100-day average as support for more than a year with only one real penetration back in February. The problem is the current spike. With the average at $56 and the price at $69 I would be crazy to wait for a hit. Instead I dial down the time frame on the chart to 30 min periods and watch for a touch of that same 100-period average.
VLO Chart - Daily
VLO Chart - 30 min
This 30/100 method works best with trending stocks like VLO or COP. For a stock that is not trending you need to experiment with the averages to see what works for that particular stock. Always start with the daily chart and the 100-day average. Then dial down the interval until you find where that average best reflects support. For instance the 200-day on the daily CHK chart is a perfect example of a support level. Others would be COP 100/30, CCJ 100/daily, BTU 100/daily but don't expect to see that any time soon. CSX 100/30, DO 50/daily, FTO 50/daily, GI 100/daily but that could be a long wait. That is a good example of dropping to the 100/30 for a quicker entry. HAL is picture perfect on both the 100/daily and 100/30. It just depends on how much patience you have.
To make this process easier I have one chart on my QCharts setup with all the moving averages I use. (30/50/100/200) One of those usually works on the daily. If not then I look at a duplicate of that chart only in a 30 min interval. It is usually very easy to see immediately where I want to place my entry. Getting the stock to cooperate is another matter. Because every stock is controlled by different elements they don't all move exactly the same way on the same day. Every night I produce a list of ten stocks I would like to buy the next day. Normally it is the same list with only a couple of changes as positions are entered. I choose the entry point I would like for each and what month/strike I will use. If I am going to be away from the computer I program my trading screen to enter the position on a touch of my target. If I am going to be trading that day I keep a watch list of the targets open and make that "emotional" decision to enter as events change.
For instance targets for Monday might include TIE @ $58, COP @ $69, TSO @ $72.50, SU @ $85, GI @ $72, CNX @ $81, VLO @ $66.50, MRO @ $82, HOC @ $80.50, UPL @ $64.50, HAL @ $80.00, PTR @ $113.50, CSX @ $67.00, XLE @ $57.50. One word of advice. The fewer targets you watch the better your entries will be. Trying to watch too many things produces confusion and causes emotional decisions.
You can never guarantee an entry because we don't have control of outside events. This is why emotion is your enemy. Traders lose more money because they refuse to wait for the entry and just jump in because they are afraid they will miss the move. Take your time and wait for the right conditions. Once you master that feat you will master trading for a living. You will miss a few moves but odds are good you will miss a few bad ones as well.
This should be an exciting week and hopefully one that continues to be profitable.
June Crude Oil futures Chart - Daily
December Crude Oil Futures Chart - Daily
Natural Gas Futures Chart - Daily
December Natural Gas Futures Chart - Daily