which way oil headed

The Case for a Crude Oil Comeback
By Kristina Zurla Landgraf ISSUE 802 | February 2009

In the summer of 2008, when crude oil topped $145 a barrel and consumers were trading in their SUVs for hybrid vehicles and even bicycles, no one would have guessed a collapse was coming. In just a few months, the price of crude fell under $40 as a global financial crisis led to a global recession. Some of our Lind Plus Market Strategists feel crude oil may be nearing a bottom, and it’s a great time to consider bullish strategies at prices that could prove to be real bargains.

Crude oil has crashed along with global demand. In December 2008, the National Bureau of Economic Research (NBER) officially declared the U.S. has been in a recession since December 2007, even before crude oil’s peak. Only two of the past 10 recessions lasted as long as a full year, according to NBER.

China’s growth has been slowing too, estimated at 6.8 percent in the fourth quarter of 2008, down from 9 percent in the third quarter. While still impressive, the fourth-quarter rate is actually the slowest for the nation in seven years. China imported 178.88 million tons of crude oil in 2008, equivalent to an average 3.59 million barrels a day. The figure closely mirrored its growth rate for the year.

The latest U.S. crude oil inventory data has supported the oil price drop. In the week ended January 23, 2009, the Energy Department reported crude oil supplies rose to 338.9 million barrels, the highest since August 2007. Crude oil inventories at Cushing, Oklahoma, the delivery point for NYMEX crude oil futures, jumped to 33.5 million barrels, a record high.

"We will need to see inventory levels start to decrease as we have ample supply in storage. The driving season will not be as big of a catalyst as we normally see unless we see better economic numbers in the next few months," said Adam Klopfenstein, Senior Market Strategist with Lind Plus. "We need to see the equity markets gain some traction to the upside for crude oil to rally as it is now moving off the economic fundamentals, he added.

However, there has been optimism the U.S. will pull out of its recession and drive energy and other markets higher as demand starts to pick up. When that improvement will take place is anyone’s guess, but many are hopeful that year-end 2009 will look much different than year-end 2008.

"As bad as the economy is, I remain convinced the market will rebound in coming months. This recent pullback presents an outstanding opportunity for traders. I recommend a strategy that involves buying puts for a short-term move even lower, and then buying futures for a longer-term rebound," said Lind Plus Senior Market Strategist Richard Ilczyszyn.

The Organization of Petroleum Exporting Countries (OPEC) has been trying to lift prices, announcing a record 9 percent cut in supply targets at a Dec. 17, 2008, meeting. OPEC won’t meet before its next scheduled summit on March 15 but members have continued to talk about future action.

Lind Plus Senior Market Strategist Tom Power notes OPEC can "only do so much," to boost prices, but eventually, crude oil will recover due to improving fundamentals.

"The combination of the proposed (U.S.) stimulus plan, previous TARP spending, a weaker dollar and a return of inflation could light a fire under crude oil prices," he said, predicting the highs of summer 2008 could be revisited, although maybe not right away.

"I believe the decline in crude will lead to amazing opportunities and it’s time to take advantage of them," Power said.

He recommends a bull call spread because of market volatility. A bull call spread is a debit spread, which involves purchasing a lower-strike call and selling a higher-strike call with the same expiration dates. The strategy has both limited profit potential and limited downside risk. It does not require margin if you want to purchase options, because your risk is defined by the price of the option.

Even if crude oil does find a spark, it may take some time to ignite, particularly with the U.S. dollar still in an upward trend. Crude oil is priced in dollars, and a stronger dollar typically sends crude oil lower as foreign purchasing power erodes. Investors are also still feeling risk-averse amid a further decline in the stock market in January and may not yet be ready to dive into commodities.

"Near-term, I think we could witness further selling in crude oil as the dollar appears to be gaining footing as a haven currency, said Lind Plus Market Strategist Mike Marshall. "Moreover, our current economic situation points toward a continuing slowdown in demand for energies. Long-term, however, I think we should see the dollar fail, pushing commodities back to an uptrend."

Some participants say it’s only a matter of time before the dollar starts to decline, because the huge government bailout plans and stimulus measures have to be financed. That will most likely lead to inflation.

"To finance this spending, the government must issue new debt and continue to print dollars, increasing the money supply. This increase in the money supply is very (dollar) bearish to me," said Lind Plus Senior Market Strategist Matt Roma. "With the return of inflation, I think we will see the return of the commodity bull market in the near-term," he said.

What do the big institutional players think? In mid-December, Goldman Sachs Group Inc. slashed its forecast for crude oil prices in 2009 to $45 a barrel. In a research note, Goldman Analyst Arjun Murti said oil prices will average $35 a barrel during the first half of 2009, then rebound to $50-$60 a barrel in the second half of the year. "We do not believe oil markets are on track for a decade-plus period of weakness like seen in the 1980s and 1990s," according to Murti,

No matter which way crude oil is headed, there are plenty of ways to participate in the market and our Lind Plus market strategists can help you formulate an appropriate strategy.