the bubble is here

June 6, 2008, 3:00 pm
Time to Short Oil?
Posted by David Gaffen
Asset prices don’t rise indefinitely — but oil is surely testing that hypothesis.

If ever a financial instrument ever seemed to be taunting the markets, the crude-oil contract is it. A brief pullback to around $122 a barrel early in the week fooled a few investors into thinking perhaps oil’s peak had passed.

But oil exploded on Thursday and Friday, gaining a ridiculous 13% on the New York Mercantile Exchange in two days to trade at $137.08. And some are saying, enough is enough.

“I think it’s ridiculous,” says Thomas H. Ruggie, founder of Ruggie Wealth Management. He says he’s contemplated shorting oil for some time, and says he would be an advocate of it, “as long as you’ve got a six-month-plus timespan, and with the understanding that the value of the short portfolio still may go down before it goes up.”

As an asset, crude oil garners a bit more respect than the average Internet stock or biotechnology play, if only because investors know all-too-well how demand is driving prices for oil and its products — such as gasoline and heating oil — higher. But Jeff Macke, writing on Minyanville.com, says this trade, and the received wisdom that goes along with it (massive demand from China and India, lackluster supply), has been heard before.

“Every bubble in history had a good story,” he writes. “If you want to get out of trading oil alive you’ll believe the charts and ignore the story because the story is eventually going to get people killed.”

Then again, the charts at this point aren’t especially encouraging for investors with the intestinal fortitude to be contrarians at this moment. The UltraShort Oil & Gas ProShares exchange-traded fund, which trades under the symbol DUG, “seeks daily investment results” that correspond to 200% of the inverse of the performance of the Dow Jones U.S. Oil and Gas Index. Headed into Friday trading it was down 23% on the year. Tim Evans, energy analyst at Citigroup, who has believed for some time that oil will fall, says it may be the time to short oil, but then again, it may not.

Oil demand fell in the first quarter, which supports the idea that prices should drop. On the other hand, “the trade is being dominated by investment flows,” he says. “The crude oil market has become a financial instrument comparable to gold, comparable to the currency markets.”

Which makes Mr. Ruggie’s itch to go short crude an idea he won’t undertake lightly. “I would probably protect myself,” he says.