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Weekly Newsletter, Saturday, 08/23/2008

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Table of Contents

  1. Commentary
  2. Changes in Portfolio
  3. Portfolio Listing & Top Picks
  4. New Plays
  5. Existing Plays
  6. Watch List

Leaps Trader Commentary

Discouraging Reversal

On Thursday crude oil rallied on a major commodity short squeeze to $122. On Friday that move was completely erased with a -$6.59 drop. The reason for the spike was supposedly the failure of the Russians to leave Georgia. That may have started the short covering but in any move of that magnitude it was the squeeze that supplied the lift. On Friday Russia completed its pull back out of Georgia and the dollar index saw a massive 61-cent spike. Both added fuel to the selling in commodities and especially oil. We saw oil go from $111.50 to $122 in just a couple days and then reverse to close at $114.59 on Friday. Volatility is still with us.

Fortunately for us the portfolio survived the week without a scratch. The stocks in the energy sector faired better than the crude contract despite giving back some ground on Friday. Unfortunately we did not add any plays either because of the rise in several stocks we were looking to buy on the dip.

You may have seen the email I sent out on Wednesday with the monster 9.4 million barrel jump in crude inventories. This was purely a catch up week for all those tankers who were in a parking orbit waiting for Eduardo to go away. You would have expected prices to drop sharply as the uneducated traders dumped positions thinking something had changed fundamentally in the oil story. With Fay running around in the gulf for the last two weeks we are liable to see the same drop in imports two weeks from now as the numbers show tankers waiting for the storm to blow over and then a spike in three weeks as the numbers catch up.

As I reported in the Option Investor commentary this weekend Fay has done the impossible. She crossed Florida from west to east, spent a day on the ocean side and then reversed course to move back into the gulf late Friday. She has drawn a bead on New Orleans and appears on a direct course to impact on Sunday. Currently the wind chart only has the outer bands stirring up trouble for the oil rigs close to shore but should she strengthen those bands would widen. There is also another storm not yet developed into the naming stage that is heading up hurricane alley between Cuba and Mexico. If that one turns into a hurricane it could be a direct hit. It should be off the coast of Venezuela by Saturday night and we should know if it is going to turn into a storm by then.

I am not going to spend a lot of time on commentary this week. I would like to invite everyone to attend the 2008 Peak Oil Conference with me on Sept 21-23 in Sacramento. About 20 Option Investor subscribers and myself will be attending and it will definitely be fun and entertaining. There are dozens of speakers and all the presentations will have reams of data on Peak Oil and its impact. It is not specifically on investing for Peak Oil although there is a presentation on that in the schedule.

The conference will convince anyone that peak oil is real and give you a countdown calendar for its arrival. I have dozens of people email me every week asking questions about peak oil. This is where to get your answers. The first day is the story and all aspects of the coming problem will be presented. The second day covers the impact. What role will coal play? What is the future for aviation? How will governments react to the changes? What hardships will ordinary people be forced to endure?

I have been to two of these ASPO conferences and it is the only conference I would not miss for the world. This is the definitive answer to all your peak oil questions.

All the Option Investor attendees will sit together so we can talk about the presentations during the breaks. I will be holding an evening session just for OI attendees and it will be Q&A and a general discussion about what we heard that day and how to profit from it. I strongly suggest anyone concerned about their future not miss this opportunity.

Go here to register: http://www.aspo-usa.org/aspousa4/

On the third page of the registration put my name in the "How did you hear" box. That way I can track the registrations and send you emails about meeting times and places.

I guarantee you will not be disappointed with what you learn.

See you in Sacramento!

Jim Brown


Readers write:

Jim - I have been a subscriber for several years and have come to value your opinion highly. Could you address these types of comments that have been coming out lately? Isn't Sept/Oct usually a time for higher oil--hard to imagine prices are going too much farther with the supply/demand issues and tensions in the world? So you think it will takes months to bottom? What are your thoughts? JK

Good question JK. I didn't include the comments from another analyst JK included suggesting oil corrections take an average of 1.2 years since we are not in normal times. I have been saying for many months that we don't really have a shortage of generic oil (all grades) just a shortage of light sweet crude that everybody wants. But even that is not really the problem.

The problem over the last six months is one of perception. Everybody thought there was a shortage because Goldman and others were coming out with their super spike theories. It is tough to believe there is plenty of oil when all the major brokers are calling for $150 to $175 oil before the year is out. I believe this developed into a self-feeding rally. Hedge funds jumped on board and kept increasing the size of their bets and I am sure a few sovereign funds from oil producing countries helped to juice the futures whenever they started to weaken.

Eventually Saudi Arabia called their bluff as they have in the past by shipping more oil than they were allowed by quota in order to take the psychological edge out of the market. Their conference helped to calm the fever and then the weight of the long positions in oil did the rest.

Oil did decline over 20% making it a technical bear market but I don't think anyone would have believed in January that we would be calling $120 oil in July a bear market. $120 oil is still expensive oil. Now that supply and demand speculation has been removed from the market we are going back to a supply/demand model at a higher price point.

OPEC will probably make an announcement they are going to enforce quotas at the Sept-9th meeting. That means Saudi will be "forced" to back off their current production but they only said they would do it for two months when they started so it is only a sound bite not a real change in policy.

The real change in OPEC's position will be when Saudi brings on the 1.2 million barrels of daily production early next year. That is in addition to their 500,000 bpd of new production scheduled for Q4 2007. This will provide a significant level of excess production and it should be reflected in oil prices even if they never open the spigots.

I posted a summary of new oil projects coming online over the next five years about a month ago in this column. You can check your back newsletter copies for the details.

Bottom line is 2009 will be a banner year for new oil production coming online. It will be the last big year according to the calendar we have today. This will keep prices from returning to the $147 level for probably the next 24 months. However, as I said earlier $120 oil or even $100 oil is very profitable oil for 99% of the energy companies. In Feb-2007 when Oil was under $60 any oil company would have never dreamed it would double in price over the next year and still be called a bear market.

I agree there are supply/demand tensions in the world. Nigeria may not return to full production of light crude for a couple years. However, we do have lots of light crude coming online from other fields over the next 18 months. Maybe not 1.5 mbpd but plenty to offset the current Nigerian shortfall.

Our biggest problem today is going to be the demand destruction we are seeing in the U.S. with demand -4% below 2007 levels. Now that prices are back in the $3.75 range SUV sales have already picked up. This is probably a knee jerk reaction and won't hold up unless prices continue to fall. Most Americans have not bought into the peak oil story yet.

So to answer your question, I do NOT believe we are in a bear market for oil. The comments you sent me from the other newsletter are not valid. That company is a serious ad spammer. They have to invent a new problem or a new discovery every month to make their next newsletter ad more enticing than the last. I subscribe to dozens of newsletters including that one and I continually laugh at the lengths they go to in selling subscriptions.

I believe oil prices will remain over $100 despite the new production because OPEC will want them to remain over $100. Also, the continued increase in demand for light crude will keep that market in tight supply. Remember to ignore OPEC comments about "market well supplied" because they are using all grades in their calculations even the ones nobody wants.

We will continue to buy the dips in oil service companies and drillers and anybody else that looks interesting. I do not expect these companies to go straight up until next years production is consumed by rising demand. Until then we will experiment with some solar plays, wind and natural gas. There are unlimited opportunities if we don't get impatient on our entries. We are entering a period where the sector will be choppy but profits will remain strong.

Jim Brown

(I am going to try and make this a weekly feature. Send me your email questions and I will try to answer. Jim @ OptionInvestor.com)


October Crude Futures Chart - Daily

September Natural Gas Futures Chart - Daily

September Gasoline Futures Chart - RBOB Daily

 


Changes in Portfolio

New Energy Plays

None - see watch list

Broad market weakness expected into September


New Non-Energy Plays

None


Dropped Plays

None


New Watch List Plays Triggered

None


Portfolio Listing & Top Picks

***********
Top Picks
***********

If you are looking to add another position these are my top picks for this week. The target prices listed would be the ideal entry points for these stocks today. There is no assurance any stock will ever return to these support levels and you will need to make your own decision about an entry point above these levels. I believe these stocks have the best potential this week. The list will change from week to week based on technicals, fundamentals, crude prices and market action. The list is not sorted in any particular order.

I strongly urge readers to be patient on new entries. We could see $110 or even $100 before the volatility is over.


 


New Plays

Most Recent Plays

None this week.
 


Play Updates

Existing Plays

XLE $74.62 +3.82 - Energy Select SPDR

Very nice rebound off support at $70 and the $2 decline on Friday was barely noticed.

The XLE is a group of 36 companies in the energy sector. Exxon is the largest component and Tesoro the smallest. See the complete list here.

ETF Info:

Energy Select Sector SPDR Fund (the Fund) seeks to provide investment results that correspond to the price and yield performance of the Energy Select Sector of the S&P 500 Index (the Index). The Index includes companies that primarily develop and produce crude oil and natural gas, and provide drilling and other energy-related services. The Fund utilizes a passive or indexing investment approach to invest in a portfolio of stocks that seek to replicate the Index. The Funds investment advisor is SSgA Funds Management, Inc.

Breakdown trigger: $72.00, hit 8/04

Position: Dec $80 Call XTG-LB @ $3.00

****************

UPL $65.65 +1.39 - Ultra Petroleum

UPL lost $6 on Thr/Fri and the implosion in nat gas. No news specific t UPL. Our stop is $58.

Prior commentary:

Ultra reported earnings on 8/05 that more than doubled the comparison quarter on a 125% increase in revenue. Production rose +23% and the average sales price of gas was $8.06 per mcf. They get less for their gas because of their location in Wyoming. Once the pipeline is finished to the east coast their profits will again accelerate sharply. They have no downside risk with an active hedging program and no offshore or out of country assets.

Breakdown trigger: $65, hit 8/05

Position: 2010 $80 LEAP WSS-AP @ $13.50

****************

APC $58.65 +1.04 - Anadarko Petroleum

Despite falling $4 from the Thursday high APC still closed the week with a gain. This is on top of a very strong gain last week. APC will present at the Lehman Energy conference on 9/3. APC cancelled a deal to do some service work with Iraq when Iraq said It was not going to sign long term contracts with those initial companies doing the front end leg work. I think it was the right idea for APC to bow out.

No change. Stop at $49.

Breakdown trigger: $55, hit 8/04

Position: 2010 $70 LEAP Call YPC-AN @ $7.60

*****************

BHP $69.54 +4.32 BHP Billiton

BHP reported record earnings and then pressed its case for the $127 billion takeover of Rio Tinto saying it makes more sense than ever to combine the two firms. Approvals from regulators are not expected until November.

Breakdown trigger: $65, hit 8/05

Position: 2010 $80 LEAP Call LPH-AP @ $9.50

********************

COP $83.18 +5.52 - ConocoPhillips

Warren Buffett may be regretting he sold his stake in COP after that $9 intraweek rebound. The $2 drop on Friday still left us with a nice gain. There was no specific news.

Earnings July 23rd, $3.50 per share

Position: 2010 $90 LEAP YRO-AR @ $11.35

********************

ENER - $79.38 +9.31 Energy Conversion Devices

Outstanding! The solar news just keeps firing up buyers of ENER. Earnings are next week (28th) and they are expected to be strong. A breakout over $82 puts ENER at a new high and in blue sky territory.

Breakout trigger: $68.50 hit 6/16

Position: 2010 $80 LEAP Call KYU-AP @ 23.10

********************

CRR $58.36 +2.36 - Carbo Ceramics

Very close to a new high and a nice gain on top of a strong gain in the prior week. Zacks continues to pound the table every other day on CRR and we are along for the ride.

Breakout trigger: $48 Hit 5/12

Position: Dec $50 Call CRR-LJ @ $5.80


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Non-Energy Positions
****************************

RIMM $131.45 +$2.65 Research in Motion

RIMM recovered from the option expiration pressures from the prior week and tested $134 on Friday. RBC said the new BlackBerry Bold now delivering in Canada is just the first in a line f new product releases. The touchscreen Thunder and Kickstart flip-phone will broaden RIMM's marketability and cut into Apple's 3G iPhone market. Palm's new Treo is not expected to impact the BlackBerry market. No change.

Prior comments:

RIMM is a combo play this time around to offset the extreme cost of the call option. We bought the call for $27.50 and sold the $110 put for $20.90 for a net debit of $6.60. In theory the call will continue to appreciate as RIMM moves higher and the put will continue to decline as it gets farther out of the money.

Breakout trigger: $125, hit 8/06

Long 2010 $140 LEAP Call YKD-AH @ $27.50
Short 2010 $110 LEAP Put YKD-MZ @ $20.90, net debit $6.60
 


Leaps Trader Watch List

Dropped Entries

None


New Watch List Entries
MOS
Mosiac

Current Watch List

HP - Helmerich & Payne

Company Info:

Helmerich & Payne, Inc. is primarily engaged in contract drilling of oil and gas wells for others. The contract drilling business accounts for almost all of the Company's operating revenues. It is also engaged in the ownership, development and operation of commercial real estate. It is organized into two separate operating entities: contract drilling and real estate. The Company's contract drilling business consists of three business segments: U.S. land drilling, offshore platform drilling and international drilling. The Company's U.S. land drilling is conducted primarily in Oklahoma, California, Texas, Wyoming, Colorado, Louisiana, Mississippi, Alabama, Arkansas, New Mexico, and North Dakota, and offshore from platforms in the Gulf of Mexico, California, Trinidad and Equatorial Guinea. During the fiscal year ended September 30, 2007, the Company's international land segment operated in seven international locations: Venezuela, Ecuador, Colombia, Argentina, Bolivia, Tunisia and Chile.

Breakdown trigger: $52 *** New Trigger ***

Buy 2010 $60 LEAP Call LQB-AL

******************

HES - Hess Corp

Company Info:

Hess Corporation (Hess) is a global integrated energy company that operates in two segments: Exploration and Production (E&P) and Marketing and Refining (M&R). The E&P segment explores for, develops, produces, purchases, transports and sells crude oil and natural gas. These exploration and production activities take place principally in Algeria, Australia, Azerbaijan, Brazil, Denmark, Egypt, Equatorial Guinea, Gabon, Ghana, Indonesia, Libya, Malaysia, Norway, Russia, Thailand, the United Kingdom and the United States. The M&R segment manufactures, purchases, transports, trades and markets refined petroleum products, natural gas and electricity. As of December 31, 2007, the Company owned a 50% interest in a refinery joint venture in the United States Virgin Islands, and another refining facility, terminals and retail gasoline stations located on the East Coast of the United States.

Breakdown trigger: $95 *** New Trigger ***

Buy 2010 $100 LEAP Call WHS-AT
Sell 2010 $90 LEAP Put WHS-MR

*******************

VLO - Valero

Company Info:

Valero Energy Corporation (Valero) owns and operates 17 refineries located in the United States, Canada and Aruba that produce conventional gasolines, distillates, jet fuel, asphalt, petrochemicals, lubricants and other refined products. The Companys principal products include conventional and California Air Resources Board (CARB) gasolines, reformulated gasoline blendstock for oxygenate blending (RBOB), ultra-low-sulfur diesel, and oxygenates and other gasoline blendstocks. Valero also produces a substantial slate of middle distillates, jet fuel, and petrochemicals, in addition to lube oils and asphalt. Valero markets branded and unbranded refined products on a wholesale basis in the United States and Canada through a bulk and rack marketing network. It also sells refined products through a network of approximately 5,800 retail and wholesale branded outlets. Effective July 1, 2007, the Company completed the sale of the Lima, Ohio refinery to Husky Energy Inc.

Breakdown trigger: $32

Buy 2010 $40 LEAP Call YPY-AH

********************

USO - US Oil Fund

I am targeting worst case here with crude falling to $100. That would take the USO to $80 and very strong support. This is a hail Mary play where we could do very good if triggered but odds of getting triggered are slim.

Company Info:

United States Oil Fund, LP (USOF) is a commodity pool that issues limited partnership interests or units that may be purchased and sold on the American Stock Exchange (the AMEX). The Company invests in futures contracts for light, sweet crude oil and other types of crude oil, heating oil, gasoline, natural gas and other petroleum-based fuels that are traded on the New York Mercantile Exchange (NYMEX), International Currency Exchange (ICE) Futures or other United States and foreign exchanges (collectively, Oil Futures Contracts). It holds interests in other oil-related investments such as cash-settled options on Oil Futures Contracts, forward oil contracts, and oil-based over-the-counter transactions. As of December 31, 2007, USOF held 4,754 Oil Futures Contracts traded on the NYMEX and 300 Oil Futures Contracts traded on the ICE Futures. The Company operates under full management control of its sole General Partner, Victoria Bay Asset Management, LLC (the General Partner).

I am not using LEAPS because I view this as a short-term trade.

Breakdown trigger: $82

Buy DEC $90 Call UNA-AL

*******************************

AAPL - Apple Computer

Despite my comments in the RIMM play description I think Apple is primed to explode when Best Buy begins selling the iPhone. This is a great entry into the mass market and 986 Best Buy stores and it will all happen in about three weeks.

Company Info:

Apple Inc. designs, manufactures, and markets personal computers, portable digital music players, and mobile communication devices and sells a variety of related software, services, peripherals, and networking solutions. The Company sells its products worldwide through its online stores, its retail stores, its direct sales force, and third-party wholesalers, resellers, and value-added resellers. In addition, the Company sells a variety of third-party Macintosh (Mac), iPod and iPhone compatible products, including application software, printers, storage devices, speakers, headphones, and various other accessories and peripherals through its online and retail stores. The Company sells to education, consumer, creative professional, business and government customers.

I am using shorter-term calls rather than LEAPS because of the extreme premium for LEAPS of $35 or more. If you have the money to play you can buy the $150 call and sell the $200 put for a net debit of about $5 and a move to $225-$250 as many analysts expect would be very profitable. The risk is 2:1 because a falling stock price increases your short put premium while your long call premium shrinks. You lose on both sides. However, if Apple rises you win big on both sides. It would not be a play for timid traders.

Breakout trigger: $182

Buy Jan 2009 $200 Call APV-AT

Breakdown trigger: $165

Buy Jan 2009 $190 Call APV-AR

********************

FLS - Flowserv

I am going to keep running this play until we get it right. Outstanding earnings, rising backlogs, no end in sight for the drilling sector.

Company Info:

Flowserve Corporation (Flowserve) is a manufacturer and aftermarket service provider of flow control systems. The Company develops and manufactures precision-engineered flow control equipment, such as pumps, valves and seals, for critical service applications. Flowserve offers a range of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting. The Company sells its products and services to more than 10,000 companies, including engineering and construction firms, original equipment manufacturers (OEMs), distributors and end users. The Company operates through three business segments: Flowserve Pump Division (FPD) for engineered pumps, industrial pumps and related services; Flow Control Division (FCD) for engineered and industrial valves, control valves, actuators and controls and related services, and Flow Solutions Division (FSD) for precision mechanical seals and related products and services

Breakdown trigger: $120

Buy Jan 2009 $140 Call FLS-AH

Breakout trigger: $138 *** new trigger ***

Buy Jan 2009 $150 Call FLS-AU

********************

PCP - Precision Cast Parts

Similar to Flowserve but different. PCP appears to have made a bottom at $92 and a break over $104 would be strong.

Company Info:

Precision Castparts Corp. is a manufacturer of complex metal components and products, provides investment castings, forgings and fasteners/fastener systems for critical aerospace and industrial gas turbine (IGT) applications. The Company also provides investment castings and forgings for general industrial, automotive, armament, medical and other applications; nickel alloys and product forms, as well as cobalt alloys, for the aerospace, chemical processing, oil and gas, pollution control and other industries; fasteners for automotive and general industrial markets; specialty alloys, waxes and metal processing solutions for the investment casting industry; refiner plates, screen cylinders and other products for the pulp and paper industry; metal-injection-molded and ThixoFormed parts for automotive and other markets; low-pressure sewer systems; gas monitoring systems for the power generation industry, and metalworking tools for the fastener market and other applications.

Breakdown trigger: $93

Buy Jan 2010 $120 LEAP Call YAM-AD

Breakout trigger: $105

Buy Jan 2010 $120 LEAP Call YAM-AD

********************

MOS - Mosaic

We are going to keep running this play until we get it right.

Company Info:

The Mosaic Company (Mosaic) is a producer of phosphate and potash crop nutrients for the agricultural industry. The Company operates its business through three business segments: phosphates, potash and offshore. The Phosphates segment produce phosphate fertilizer and feed phosphate which are used in crop nutrients and animal feed ingredients, respectively. The principal inputs used in crop nutrients production are phosphate rock, sulfur and ammonia. The Potash segment mines ad processes potash in Canada and the United States and sells potash in North America and internationally. The Offshore segment produces and markets fertilizer products and provides other ancillary services to wholesalers, cooperatives, independent retailers, and farmers in South America and the Asia-Pacific regions. As of May 31, 2008, Cargill, Incorporated owned approximately 64.4% of the Companys interest. As of May 31, 2008, the Company had a 50% interest in Saskferco Products Inc.

Breakout trigger: $117

Buy Jan 2009 $140 LEAP Call LXW-AX

Breakdown trigger: $95

Buy Jan 2009 $120 LEAP Call LXW-AD
 


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