Option Investor

Long Term Buying Opportunity

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I know you have heard before about strong support at XXX level and prices should rebound from here but I really believe we are near a bottom with oil at $50. Unfortunately I thought that at $70 and $60 and several other support points on the way down.

The volatility in the markets is extreme. The Dow traded in a 19% range over the last two weeks. The Banking index hit a 30% range. This is the worst trading environment in my lifetime. Making money in this market is nearly impossible if your time in the trade is more than a couple hours. Those playing puts are getting taken out on +500 point days while call players are getting killed on -500 point drops. Twice now those moves both happened on the same day.

The gap down last Thursday flushed the energy portfolio as crude fell from $55 to under $49 and the broader markets led by the Dow loss of more than 1000 points in three days crushed everything else. The soft bottom retest from last week was erased with lower lows on every index. The S&P hit an 11 year low at 741.

There are no safe havens but everything is pointing to a potential end of the bear market coming soon. Soon could be next week or next month but soon. Secular bear markets typically fall 45% to 50% and we are there now. They typically last 12-18 months and we are in the 13th month now. However, with the advent of the Internet age and online trading and news delivery that historical time frame in every market cycle has been shortened. Events happen faster and they are more volatile. The VIX has hit new decade highs in this cycle and Thursday saw a retest of resistance at 80. This could easily be a double top for the VIX.

VIX Chart
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We are undergoing some spectacular market moves on some unbelievable financial and economic events. I wrote in the Option Investor market wrap this weekend that ten companies with total assets of more than $5 trillion have failed or been taken over by the government in the last couple months. Citigroup could be next as soon as this weekend. This is truly a once in a lifetime event. All the normal rules of market behavior have changed.

The rapid arrival of a global recession only 4 months from a peak is unbelievable. Crude prices have fallen nearly $100 from the July high on fears of a global recession, demand destruction from all time high prices and the implosion of the hedge funds that made a market in commodities.

The price of oil will return to the highs but probably not in 2009. The current low price is doing irreversible harm to future production. Exploration and Development projects are being cancelled or postponed at a frantic pace. With each project cancelled we are losing momentum on the supply side. This is momentum that may not ever be regained.

Depletion never sleeps. It does not ebb and flow with the demand cycles. Depletion accelerates with the age of the fields and every field grows older every day. The wild card here is demand. Just as demand crashed with $4 gasoline and the arrival of a global recession it can rebound just as quickly. Every global government of any size is implementing economic stimulus to make sure the recession is short lived but the biggest economic stimulator is cheap energy. Oil is the fuel of economic expansion. With oil at $50 and even more unbelievable gasoline futures at $1 per gallon the seeds of the next economic boom have already been planted. We may not see a return in four months to the economic boom from last spring but we will see the rebound in 2009. Cheap gasoline knows no racial, geographic or economic boundary. It is the greatest stimulus package ever known and it requires no advertising and no checks in the mail. It is here now and we can expect to see the results very soon.

This is one reason I believe the markets are at or near a bottom. I believe the next few weeks are a buying opportunity but there may still be some major events to rock the markets. If your time horizon is calculated in years then this is the buying opportunity of the decade. If you are going to be in a position for less than a year or more then the road ahead may still be rocky. After getting blown out of our positions on last week's volatility I am not brave enough to charge back into battle with a full portfolio today. The developments at Citigroup, Goldman Sachs and AIG could still produce new lows for the equity markets if not handled correctly.

In the energy markets the Obama team have made it clear that negative changes are coming for coal fired electric generation and there will be big changes for electricity generation in general. The coal sector is crashing because of the coming changes. The new discoveries in shale gas and techniques for its retrieval has pushed gas prices back to $6 and it has the potential to go lower. This is weighing heavily on the nat gas sector. OPEC can't get its act together and the announced production cuts have not been enacted by many OPEC nations. Future announcements will have no impact until trackers report that production is actually slowing.

This may actually be the biggest plus for the overall markets. If OPEC nations continue to flood the markets with oil we will see prices plunge even farther. Cheaper oil equals cheaper gasoline and a faster economic recovery. As investors in the energy sector this could still mean lower prices ahead for energy stocks making this a long term buying opportunity rather than a short-term trade. We need to watch for signs of a cycle change rather than try to pick a bottom in the price of oil.

I wrote about the continuing hedge fund de-leveraging we are seeing now as well as the collapsing mutual fund sector. All of these liquidation events could continue to pressure the markets through year-end and into January. There are two different cycles here. There is one liquidation process that must generate cash before year-end and another one in the case of mutual funds that will force selling the instant the calendar year ends. We have seen the big drops in early January many times in recent years as funds dump positions once the tax year closes. I believe this will make the next six weeks very unpredictable and I am in no rush to jump back into a lot of positions.

Look for my update on the IEA World Energy report in a special email later this weekend.

Jim Brown

January Crude Futures Chart - Weekly
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December Natural Gas Futures Chart - Weekly
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December Gasoline Chart - Weekly
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