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Why Fracking Will Make Your 2015 Performance

Be nice to investors on the way up, because you always meet them again on the way down. This is the harsh reality of those who have placed their money in the fracking space this year.

The hottest sector in the market for the first half of the year, investors have recently fallen on hard times, with the price of oil collapsing from a $107 high in June to under $77 this morning, a haircut of some 28% in just five months.

Prices just seem to be immune to all the good news that is thrown at them, be it ISIL, the Ukraine, or Syria.

It wasn?t supposed to be like that. Using this revolutionary new technology, drillers are in the process of ramping up US domestic oil production from 6 million to 10 million barrels a day.

The implications for the American economy have been extraordinarily positive. It has created a hiring boom in the oil patch states, which has substantially reduced blue-collar unemployment. It has added several points to US GDP growth.

It has also reduced our dependence on energy imports, from a peak of 30 quadrillion Btu?s in 2005 to only 13 quadrillion Btu?s at the end of last year. We are probably shipping in under 10 quadrillion Btu?s right now, a plunge of 66% from the top in only 9 years.

The foreign exchange markets have taken note. Falling imports means sending hundreds of billions of dollars less to hostile sellers abroad. Am I the only one who has noticed that we are funding both sides of all the Middle Eastern conflicts? The upshot has been the igniting of a huge bull market in the US dollar that will continue for decades.

That has justified the withdrawal of US military forces in this volatile part of the world, creating enormous savings in defense spending, rapidly bringing the US Federal budget into balance.

The oil boom has also provided ample fodder for the stock market, with the major indexes tripling off the 2009 bottom. Energy plays, especially those revolving around fracking infrastructure, took the lead.

Readers lapped up my recommendations in the area. Cheniere Energy (LNG) soared from $6 to $85. Linn Energy (LINE) ratcheted up from $7 to $36. Occidental Petroleum moved by leaps and bounds, from $35 to $110.

Is the party now over? Are we to dump our energy holdings in the wake of the recent calamitous falls in prices?

I think not.

One of the purposes of this letter is to assist readers in separating out the wheat from the chaff on the information front, both the kind that bombards us from the media, and the more mundane variety emailed to us by brokers.

When I see the quality of this data, I want to throw up my hands and cry. Pundits speculate that the troubles stem from Saudi Arabia?s desire to put Russia, Iran, the US fracking industry, and all alternative energy projects out of business by pummeling prices.

The only problem is that these experts have never been to Saudi Arabia, Iran, the Barnett Shale, and wouldn?t know which end of a solar panel to face towards the sun. Best case, they are guessing, worst case, they are making it up to fill up airtime. And you want to invest your life savings based on what they are telling you?

I call this bullpuckey.

I have traveled in the Middle East for 46 years. I covered the neighborhood wars for The Economist magazine during the 1970?s.

When representing Morgan Stanley in the firm?s dealings with the Saudi royal family in the 1980?s, I paused to stick my finger in the crack in the Riyadh city gate left by a spear thrown by King Abdul Aziz al Saud when he captured the city in the 1920?s, creating modern Saudi Arabia.

They only mistake I made in my Texas fracking investments is that I sold out too soon in 2005, when natural gas traded at $5 and missed the spike to $17.

So let me tell you about the price of oil.

There are a few tried and true rules about this industry. It is far bigger than you realize. It has taken 150 years to build. Nothing ever happens in a hurry. Any changes here take decades and billions of dollars to implement.

Nobody has ever controlled the market, just chipped away at the margins. Oh, and occasionally the stuff blows up and kills you.

As one time Vladimir Lenin advisor and Occidental Petroleum founder, the late Dr. Armand Hammer, once told me, ?Follow the oil. Everything springs from there.?

China is the big factor that most people are missing. Media coverage has been unremittingly negative. But their energy imports have never stopped rising, whether the economy is up, down, or going nowhere, which in any case are rigged, guessed, or manufactured. The major cities still suffer brownouts in the summer, and the government has ordered offices to limit air conditioning to a sweltering 82 degrees.

Chinese oil demand doubled to 8 million barrels a day from 2000-2010, and will double again in the current decade. This assumes that Chinese standards of living reach only a fraction of our own. Lack of critical infrastructure and storage prevents it from rising faster.

Any fall in American purchases of Middle Eastern oil are immediately offset by new sales to Asia. Some 80% of Persian Gulf oil now goes to Asia, and soon it will be 100%. This is why the Middle Kingdom has suddenly started investing in aircraft carriers.

So, we are not entering a prolonged, never ending collapse in oil prices. Run that theory past senior management at Exxon Mobil (XOM) and Occidental (OXY), as I have done, and you?ll summon a great guffaw.

It will reorganize, restructure, and move into new technologies and markets, as they have already done with fracking. My theory is that they will buy the entire alternative energy industry the second it become sustainably profitable. It certainly has the cash and the management and engineering expertise to do so.

What we are really seeing is the growing up of the fracking industry, from rambunctious teenage years to a more mature young adulthood. This is its first real recession.

For years I have heard complaints of rocketing costs and endless shortages of key supplies and equipment. This setback will shake out over-leveraged marginal players and allow costs to settle back to earth.

Roustabouts who recently made a stratospheric $200,000 a year will go back to earning $70,000. This will all be great for industry profitability.

What all of this means is that we are entering a generational opportunity to get into energy investments of every description. After all, it is the only sector in the market that is now cheap which, unlike coal, has a reasonable opportunity to recover.

Oil will probably hit a low sometime next year. Where is anybody?s guess, so don?t bother asking me. It is unknowable.

When it does, I?ll be shooting out the Trade Alerts as fast as I can write them.

Where to focus? I?ll unfurl the roll call of the usual suspects. They include Occidental Petroleum (OXY), Exxon Mobil (XOM), Devon Energy (DVN), Anadarko Petroleum (APC) Cabot Oil & Gas (COG), and the ProShares 2X Ultra Oil & Gas ETF (DIG).

Fracking investments should be especially immune to the downturn, because their primary product is natural gas, which has not fallen anywhere as much as Texas tea. Oil was always just a byproduct and a bonus.

CH4 was the main show, which has rocketed by an eye popping 29% to $4.57 in the past two weeks, thanks to the return of the polar vortex this winter. We are now close to the highs for the year in natural gas.

The cost of production of domestic US oil runs everywhere from $28 a barrel for older legacy fields, to $100 for recent deep offshore. Many recent developments were brought on-stream around the $70-$80 area. So $76 a barrel is not the end of the world.

On the other hand, natural gas uniformly cost just under $2/Btu, and that number is falling. Producers are currently getting more than double that in the market.

And while on the subject of this simple molecule, don?t let ground water pollution ever both you. It does happen, but it?s an easy fix.

Of the 50 cases of pollution investigated by MIT, most were found to be the result of subcontractor incompetence, natural causes, or pollution that occurred 50 or more years ago. Properly regulated, it shouldn?t be happening at all.

When I fracked in the Barnett Shale 15 years ago, we used greywater, or runoff from irrigation, to accelerate our underground expositions. The industry has since gotten fancy, bringing in highly toxic chemicals like Guar Gum, Petroleum Distillates, Triethanolamine Zirconate, and Potassium Metaborate.

However, the marginal production gains of using these new additives are not worth the environmental risk. Scale back on the most toxic chemicals and go back to groundwater, and the environmental, as well as the political opposition melts away.

By the way, can any readers tell me if my favorite restaurant in Kuwait, the ship Al Boom, is still in business? The lamb kabob there was to die for.

Don?t Throw Out the Baby with the Bathwater

Oil Isn't What It Used to Be

Diary, Free Research, Newsletter

With the International Energy Agency cutting global consumption by 200,000 barrels a day in 2014 and 300,000 barrels a day in 2015, all eyes were on the oil market today. I had to slap myself when I saw the $81 handle for West Texas intermediate, it had gotten so cheap so fast.

Virtually every stock market analyst has been puzzled by the seeming immunity of stock markets to the good news of collapsing oil prices (USO), (DIG), (DUG) this year.

In fact, stocks and crude have been tracking almost one to one on the downside. The charts below, sent by a friend at JP Morgan, go a long way towards explaining this apparent dichotomy.

The first shows the number of barrels of oil needed to generate a unit of GDP, which has been steady declining for 30 years. The second reveals the percentage of hourly earnings required to buy a gallon of gasoline in the US, which has been mostly flat for three decades, although it has recently started to spike upwards.

The bottom line is that conservation, the roll out of more fuel-efficient vehicles and hybrids, and the growth of alternatives, are all having their desired effect.

Notice how small all the new cars on the road are these days, many of which get 40 mpg with conventional gasoline engines. As for my own household, it has gone all-electric.

Developed countries are getting six times more GDP growth per unit of oil than in the past, while emerging economies are getting a fourfold improvement.

The world is gradually weaning itself off of the oil economy. But the operative word here is ?gradually?, and it will probably take another two decades before we can bid farewell to Texas tea, at least for transportation purposes.

It took 150 years for America to build its oil infrastructure. Don?t expect it to disappear in 10 or 20 years. Those outside the oil industry are totally unaware how massive the industry is that has to move around our country?s 18.8 million barrels a day, refine it into usable products, and get it to the end individual, industrial and government consumer.

But the Mileage is Great!

Gasoline? What?s that?

How Low is Low for Oil?

Diary, Newsletter, Research

With the recent collapse in oil prices, down a whopping $20 in just four months, I am starting to get a lot of emails from followers looking for Trade Alerts to buy the energy companies.

After all, energy is one of my three core industries in which to invest over the next two decades. Why not now?

The short answer is: Not yet. Don?t ever confuse a stock that has gone down a lot with ?cheap.?

The share prices for this sector are getting so low, they are starting to redefine the meaning of ?bargain.? The major integrated oil companies are now trading under book value with single digit multiples.

They are now at liquidation values, assuming that the fall in the price of Texas tea halts at $80. Those are valuations almost as low as Apple (AAPL) saw a year ago.

The absence of my Trade Alerts in this fertile field is happing because things could get worse for oil before they get better. There is now a war for market share occurring between the world?s second and third largest producers, Saudi Arabia and Russia (the US is now number 1).

Both countries desperately depend of rising prices and export volumes to maintain domestic political stability. When that doesn?t happen, budget deficits explode, spending gets cut, revolutions occur, and governments fall.

And these aren?t countries that send former leaders to country clubs to practice their golf swings in retirement. Firing squads are more the order of the day. In fact, countries maintaining high oil revenues is a matter of personal survival for their leaders.

Until recently, I would have said that China would step in and put a floor under the market to fuel their insatiable demand for energy. But they have run out of storage, and are unable to take more.

There is just no place to put it. They have even resorted to long-term charters of ultra large tankers, like the 434,000 tonne TI Europe, purely to build reserves.

The shake out is especially bad in the offshore sector, the planet?s most expensive source of crude. A glut of new drilling rigs is about to hit the market, ordered during more prosperous times years ago, while existing ones can be snapped up for 60 cents on the dollar.

Oil suffers from the additional damnation in that it is being dragged down by the global commodity collapse. Unless an asset class is made out of paper and pays an interest rate or a dividend, it is getting dissed to an unbelievable degree.

All of this means that the price of oil could fall further before we hit bottom and bounce. Now that $90 has been decisively broken, $80 is in the cards, and possibly $70 on a spike.

If you had told me when I was fracking for natural gas in the Barnett Shale 15 years ago that this process would ultimately cause the collapse of Russia and Saudi Arabia, me and my roustabout buddies would have said you were nuts. Yet, that is precisely what seems to be happening.

If there is one thing saving Texas tea, it is that the US can?t build energy infrastructure fast enough to get burgeoning new supplies to market. After the Keystone Pipeline got stalled by regulatory roadblocks, giant 100 car oil trains sprang out of nowhere overnight.

So many railcars have been diverted to the oil trade that farmers are now having trouble getting a record grain crop to market. This is why railroads have been booming (click here for ?Railroads Are Breaking Out All Over?).

The energy research house, Raymond James, recently put out an estimate that domestic American oil production (USO) would rise to 9.1 million barrels a day by 2015. That means its share of total consumption will leap to 46% of our total 20 million barrels a day habit. These are game changing numbers.

Names like the Eagle Ford Shale, Haynesville, and the Bakken Shale, once obscure references on geological maps, are now a major force in the country?s energy picture.

Ten years ago, North Dakota was suffering from depopulation. Now, itinerate oil workers must brave -40 degree winter temperatures in their recreational vehicles pursuing their $150,000 a year jobs.

The value of this extra 3.5 million barrels/day works out to $115 billion a year at current prices (3.5 million X 365 X $90). That will drop America?s trade deficit by nearly 25% over the next three years, and almost wipe out our current account deficit.

Needless to say, this is a hugely dollar positive development, and my own Trade Alerts have profitably been reflecting that.

This 3.5 million barrels will also offset much of the growth in China?s oil demand for the next three years. Fewer oil exports to the US also vastly expand the standby production capacity of Saudi Arabia.

If you want proof of the impact this will have on the economy, look no further than the coal (KOL), which has been falling in a rising market. Power plant conversion from coal to natural gas (UNG) is accelerating at a dramatic pace. That leaves China as the remaining buyer, and their economy is slowing.

It all makes the current price of oil at $90 look a little rich. As with the last oil spike four years ago, this one is occurring in the face of a supply glut. Cushing, Oklahoma is awash in Texas tea, and the Strategic Petroleum Reserve stashed away in salt domes in Texas and Louisiana is at its maximum capacity of 727 million barrels.

It was concerns about war with Syria, Iran, ISIL, and the Ukraine that took prices to $107 in the spring. My oil industry friends tell me this fear premium added $30-$40 to the price of crude. That premium is now disappearing.

It seems that every time a new group grabs an oil field in the Middle East, they ramp up production, rather than destroy it, so they can milk it for the cash. This is why 15 tankers are afloat around the world carrying Kurdish crude to sell on the black market.

Once Europe and Asia return to a solid growth track, oil will recover to $100 a barrel or more. Until then, discretion is the better part of valor, and I?ll be sitting on those Trade Alerts.

It is also why I am keeping oil companies with major onshore domestic assets, like Exxon Mobil (XOM) and Occidental Petroleum (OXY), in my long term model portfolio.

Sorry, but We?re Full

How the Ukraine Crisis Will Play Out

Newsletter, Research

I can tell you exactly how the crisis in the Ukraine is going to play out. This has major implications for the global economy, financial markets and your personal portfolio, so listen up!

The key to deciphering this puzzle is oil, far and away Russia?s largest export. At 10 million barrels a day, the country is taking in $360 billion a year in revenues from oil shipments.

You can analyze Russia all day long, and come up with bullish arguments for the country, like the emerging middle class, its huge hoard of basic commodities, and substantial wheat exports. But Texas tea (Russian tea?) overwhelms everything else in its impact on the national accounts.

The bottom line is that Russia is basically a call option on oil. This is why I never buy the Market Vectors ETF Trust (RSX). Look at the charts below for oil, and it is clear that it almost trades tick for tick with the (RSX).

If I?m bullish on oil, I go straight to the end commodity, and not the intermediary, where price earnings multiples are permanently low, corruption is rampant and the rule of law is absent.

And therein lies the problem for Vladimir Putin.

Any chink in the global growth picture flows straight into the price of oil. Slower growth brings lower oil prices and therefore smaller incomes for the Russians. And guess who the principal threat to global growth is? Vladimir Putin and his attempt to take over the Ukraine by force.

So far, crude has dropped by 10% from the May peak of $107.60. That may not sound like a lot. But this is not your father?s Russian oil industry.

Back in the old days, when my friend, Occidental Petroleum?s (OXY) Dr. Armand Hammer and Fred Koch were the only Americans running around the Caucasus, oil there was incredibly cheap. There, technology was 50 years old and labor was virtually free. Slave labor is great for profit margins. If you don?t believe me, just ask Wal-Mart (WMT) and Apple (AAPL).

The fall of the Berlin Wall and the end of the Soviet Union brought many far-reaching, unintended consequences. A big one is that Russia?s dependence on international trade grew tremendously. The country was also able to modernize its oil industry with extensive American assistance.

Russian oil production exploded, as did the cost of production. In my lifetime, expenses have soared from $5 to $70 a barrel. So when oil dips by 10% on the international markets, Russian incomes plunge by 25%. The Russian oil industry has become a highly leveraged affair.

This is why such relatively minor price declines brought apparently desperate actions by the Russian authorities to prop up the economy. They have imposed a 3% emergency VAT, or sales tax. While I was in Europe, four Russian tour companies were driven into bankruptcy by the banking sanctions, stranding some 10,000 tourists on Mediterranean beaches.

Now there is a ban on food imports from Europe, stranding thousands of trucks at the Russian borders. Russia doesn?t grow much food, thanks to their horrendous winters and short growing seasons. Essentially, it?s just wheat and potatoes.

Everything else has to be imported. Some of the lost food can be made up with new imports from emerging, non sanctioning economies, but not much. In the meantime, some 350 McDonald?s franchises in Russia are trying to figure out how to make Big Macs purely from domestic supplies. Good luck to that!

The thing that really struck me speaking to Russians in Europe this summer was Putin?s unbelievably high 85% approval rating (our congress is at 14%!). They trotted out the most incredible conspiracy theories which painted them as the injured party. (The Ukraine was trying to assassinate Putin when it shot down Malaysian Air 17, and then blamed it on Russia).

It almost reminded me of home. The Russians are calling their opponents ?fascists.? This is a people who act like WWII ended last week.

Which leads me to believe that Putin?s popularity is peaking. The sanctions coupled with falling oil revenues are starting to have a severe impact on Russian standards of living. It is a matter of time before this feeds into poor election results for Putin. Nationalism is great, but who wants to live on canned food left over from the Soviet Union (yuck!).

Putin knows this. So to head off the riot, he is going to declare victory in the Ukraine fairly soon, and then take his troops home. This will enable the Ukraine to snuff out the separatists and return to an uneasy peace. We might even luck out and get a written treaty.

If that is a case, you can expect global financial markets to rocket. There would me a massive shift of capital out the risk spectrum, out of bonds and into stocks. This would give the green light for my scenario where S&P 500 adds 10% from last week?s low to end of 2014.

Maybe this is what stocks are trying to tell us by refusing to go down more that 5% this summer and the face of a host of geopolitical disasters.

As for the exact timing for all of this, just watch the price of oil. The lower it goes, the sooner we will get a favorable resolution. The charts are hinting that another $5-$10 break to the downside is imminent.

The last Cold War drove the Soviet Union broke and Putin definitely has no interest in repeating the exercise.

Not Until the Sanctions Are Over

The New War in the Ukraine

Newsletter

It was another one of those midnight calls from my old KGB friend.

Yuri was assigned to tail me in Tokyo during the 1970?s. He even came to my wedding as the official TASS correspondent. We have stayed in touch ever since. After the fall of the Soviet Union, he landed on his feet (as did his buddy, Vladimir Putin), eventually ending up in the hedge fund industry.

Yuri told me that Moscow had just dispatched another 6,000 heavily armed troops to its naval bases in Crimea, part of the Ukraine, and more were on the way. There, Russia has long-term leases; much like the US still has a presence in Guantanamo, Cuba. It is a crucial defensive arrangement that gives Russia access to its only all year, warm water ports.

The markets certainly voted with their feet, belying Russia?s important role in the global economy. A shooting war in the Ukraine would block the oil terminals for Russia?s largest export, choking off a principal source of revenue for the government, prompting Brent to pop $2.50. This is why Hitler invaded the region in 1942. It was all about energy, as it always is.

That will certainly be welcome news in Moscow. Indeed, boosting the price of Russia?s largest earner is seen by many as the principal impetus for the aggressive military move. That?s good for Putin, but bad for us.

You also saw higher prices for natural gas, another huge export from Russia to Europe, where the pipelines also cross the Ukraine. But gas is not an internationally traded commodity, just a collection of disparate local markets, so the impact in the US will be minimal. The coming spring is the big issue for this market.

Wheat, however, is another story. The Ukraine is one of the world?s principal grain exporters. This is why Napoleon invaded Russia in 1812. Take Ukraine out of the market, and several Middle Eastern countries quickly go hungry.

They certainly figured this out quickly in the Chicago pits, where prices (WEAT) rocketed by 5%. The move caught many traders short, who were anticipating a continuation of the three-year bear market.

Of course, stocks everywhere were trashed, especially the Market Vectors Russia ETF Trust (RSX), which dove by 17% since the crisis began two weeks ago. Normally, the (RSX) rises in tandem with appreciating oil prices. But nobody cares, as emerging markets (EEM) have been out of favor for some time, and once again are one of the worst performing asset classes in 2014.

Knowing that my friend has a strong history bent, as I, I asked if we were heading into a second Crimean War, Russia having won the last one in 1856 (remember the Charge of the Light Brigade?). Worse, is World Way III on its way? Russia still has 8,800 nuclear weapons, compared to our 3,500 (we bought their other 6,000 to run our nuclear power plants after the fall of the Soviet Union).

Not a chance, he replied. There is a reason why Russians are Grand Master chess players. The entire reason behind the crisis was to preserve Russia?s interests in any new Ukrainian government, the last one having just scampered off to collect on their Swiss bank accounts.

Be nice, and the troops go home. Be not so nice, and there will be a massacre, with Russia the overwhelming winner. Ukrainian troops are wisely confined to base, and there is no movement of Russian ships whatsoever. The signs of escalation are nowhere.

All of my contacts in Russia tell me that the chances of war happening are nil. Russia has such an overwhelming military advantage that this is a conflict that will be solved by writing checks, and not pulling triggers.

Remember, Russian leaders are all about projecting strength and are great at bluffing. (During the 1962 Cuban missile crisis, Nikita Khrushchev possessed only four operational atomic bombs). This is why Clint Eastwood is such a big movie star there.

Unfortunately, the Ukraine traded off all of its nuclear weapons in exchange for European security guarantees, which today are not worth the paper they are written on.

It all amounts to a storm in a teacup if you live anywhere but the Ukraine. The real concern is what Putin will do next. Thus emboldened, he may pick off another former Soviet Republic. This goes down very well with his domestic, nationalist base, which is still angry over their loss of the cold war.

If Putin continues his expansionist military policies, it could eventually lead to a return of the cold war. That would be a huge buzz kill for our bull market in stocks, as the peace dividend goes up in smoke and our economy returns to a war footing. At the end of the day, that would come straight out of corporate earnings, and your pockets.

Fortunately, a new cold war is highly unlikely. The last one drove the Soviet Union into bankruptcy. In the end, we outspent them to death. Our credit card was bigger than theirs. A much smaller Russia isn?t going to rejoin a losing game. America?s military has grown dramatically since then, with the increase almost entirely financed by China. Russia?s military virtually no longer exists, and no one anywhere is willing to bankroll a new one.

What this means for out markets is that no matter how ferocious today?s action, it is only a temporary event. It is curing an overbought condition is risk assets everywhere. After the usual over leveraged stop loss selling, it won?t take long for stocks to resume the upside, and bonds to take another dump. For more detail on how and why this is going to play out, please read yesterday?s letter.

I told my friend, Yuri, thanks and said I owed him another bottle of Stolichnaya vodka. By the way, how is the weather in Crimea in August? I hear beach house rentals there have suddenly gone begging.

A Clever Chess Move?

Bailing on My Oil Short

Newsletter

We got the dollar drop over the weekend that I was expecting. There was no way that the war was going to start before Obama gave his speech on Tuesday and congress votes yea or nay later on.

So when the missiles failed to show by the Monday morning opening, they took Texas tea down a full buck. The Charlie Rose interview with Bashar al-Assad, where he blamed it all on the rebels, also cast more doubt on the prospect of immediate hostilities.

Don?t kid yourself. There is going to be a war. Over the weekend, I did manage to get a peek at the classified proof of the sarin gas attack, thanks to some senior military sources at the Pentagon.

It includes recordings of radio transmissions from Syrian generals ordering the use of poison gas to teach a lesson, and other recordings of radar tracks showing the missiles flying from a Syrian army base to a Damascus neighborhood. You are not going to get a better smoking gun than that.

The Russians were not given access to this data to keep sources, methods, and the advanced state of our monitoring technology, secret. Besides, relations with the Ruskies have been pretty rocky lately. This is why President Obama said at the St. Petersburg press conference that he was elected to end wars, not start new ones, based on false information, a jab at the originators of the 2002 second Gulf War.

However, it?s time to use this window to cut our losses on our United States Oil Fund September, 2013 $39-$42 in-the-money bear put spread, which is now out-of-the-money, if just a touch. Think of it has folding your hand and losing your ante when the dealer has an ace showing in Texas hold?em.

Everything that can go wrong with a trade happened with this one. My initial assumption that Egypt would go to sleep in the wake of the army massacre of 1,000 protesters proved correct. At first, my oil short made money, as oil fell from $108 a barrel to $105, taking the (USO) down with it.

Then Secretary of State John Kerry made his blockbuster, saber rattling speech, ramping up speculation about a new war in Syria by a quantum leap. Oil soared to $112.50. Since then, it has been all back and fill, based on the totally unpredictable headline?du jour, with most of the movement occurring in an untradeable daily gap opening.

There are only nine trading days left to expiration on this position. We would make money with an expiration at this level with the (USO) a mere 25 cents in-the-money.

But the risk/reward of continuing has gone asymmetric against us, meaning that we are risking a lot of money here to make just a little bit. It is not worth it. If things suddenly go against us, like missiles actually flying, a 1.18% loss could turn into a sickening 10% one very quickly. And with nine days to expiration, there is not enough time for conditions to turn right for us once again.

It easier to take a loss when your overall profit reaches another all time high. As of now, the?Trade Alert?service of the?Mad Hedge Fund Trader?is up a hefty 41.48%, thanks to my major short in the Japanese yen. I would hate to lose a quarter of this on a single rogue trade, thanks to some Middle Eastern warlord.

I already have plans on how to spend this money, like buying a second Tesla, the four wheel drive SUV model X, which will probably set me back another $100,000. I am not going to let oil pee on my parade.
When war does break out, and then escalates, and we get the spike up to $118 that many are predicting, then you?ll see me re emerge as a seller once again. If anything, the underlying supply/demand dynamics are getting worse, with the precipitous size of the Wall Street long position in oil rising, while underlying demand is melting away like an ice cube in the desert. For explanations of the fundamentals here in eloquent and florid detail, please read ?Why I Sold Oil? by?clicking here?and ?Why I?m Keeping My Oil Short? by?clicking here?at.

On to the next trade.

A Tesla Model ?X?

Why I?m Keeping My Oil Short

Newsletter

Let?s call this the weekend of love. On Friday morning, we were looking forward to a long weekend of missiles raining down on Syria and the regional conflagration that would follow. The price of oil reflected as much, with west Texas intermediate trading all the way up to $112.50.

Then the British Parliament voted against their country?s participation under any circumstances. President Obama then dropped a bombshell of his own, asking congress for a resolution approving military action. He made this request of the least productive congress in history, one that rarely approves anything, whose sole mission is to oppose and embarrass Obama in all circumstances. Flocks of doves were seen circling the capitol dome. The next print for oil was $106.

Obama?s move is entirely political and very clever. He has put the Republicans in the uncomfortable position have having to vote against military action, something they have been clamoring for over the last two years. The sole exception here is the libertarian wing of the party lead by Senator Rand Paul of Kentucky, who opposes all wars for cost reasons.

More importantly, constitutional law professor Obama is setting an important legal precedent here, requiring a congressional declaration of war on this, and all future, military actions. The United States has not declared war on anyone since it did so against Japan in December, 1941 in the wake of the Pearl Harbor surprise attack. Every war since then, and there have been more than 20, has been solely at the discretion under the cover of the War Powers Act. Of the last 23 years, America has been at war for 14 years without any official declaration. The president is not only asking for belt and braces support for an attack on Syria, but also placing the legal handcuffs on all future warlike presidents.

My short position in oil through my bear put spread on the United States Oil Fund (USO) has certainly given me a roller coaster that I had not bargained for. I sold it expecting that the turmoil in Egypt has peaked for the short term. That assessment turned out to be correct. Then we got confirmation of the poison gas attack, something you don?t want to hear about when you are short oil. Only Israel?s missile test today is preventing oil from falling further, fast. Welcome to the oil market.

After the weekend?s action, the oil market has entirely backed out the Syria gas attack. I was sure we were in for a quiet weekend, as there was no way that the US would attack with UN inspectors still in Syria. That would be rude beyond belief. I was definitely paid for my beliefs. My loss on my oil short was pared back from hair raising to moderate. Better news was the gains I scored in my yen and euro shorts, which both collapsed on the dovish news.

So what to do about the (USO) from here? I think that congress will eventually vote for an attack, providing Obama with the fig leaf he is demanding. Oil will spike again when the missiles eventually fly. But with the congressional sand now in the works, that could take weeks, or even months. In the meantime, my options position in the (USO) expires in 13 trading days. So at this point, I am inclined to hang on, run out the clock, and sing anti war ballads until then.

When we do get the next spike in prices, I will sell short again in double the size. Now that the summer is over, the actual supply/demand picture for oil is terrible (click here for ?Why I Sold Oil). Wall Street is holding a record long in the futures market, which will soon come to grief, once the news flow from the Middle East slows.

I am inclined to do so with outright puts only, instead of a put spread to maximize my short-term profits. I may also buy some of the ProShares UltraShort DJ-UBS Crude Oil ETF (SCO), a 200% short fund that profits from falling oil prices (click for the link for the website http://www.proshares.com/funds/sco.html ). I think that the final end game here is for Texas Tea to grind down to $92 over coming months, a prolonged move that an ETF is better disposed to profit from. A 20% drop from the top is certainly something worth taking a bite out of.

Battle Testing Your Portfolio

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The great thing about the sudden $5 pop is the price of oil since Monday is that it battle tests your portfolio. You really don't know what you own and the risks it entails until something like this comes along. I'll explain why.

For a start, you get a very clear idea of which of your assets are of the "RISK ON" variety, and which are of the "RISK OFF" persuasion. This is easier said than done because asset classes often change gender, flipping from "RISK ON" to "RISK OFF" without warning. Knowing which is which is crucial in hedging portfolios and measuring your risk. It is not unusual for a trader to believe he has a safe bet on, only to watch his portfolio completely blow up because the cross asset relationships have changed.

Look at Tuesday's market action. Traditional "RISK ON" assets, like stocks (SPY), got pounded. The traditional flight to safety assets, such as bonds (TLT) and gold, did well. This is where a typical balanced portfolio does well. Oil (USO) is usually a "RISK ON" asset, but not this time. Fears of a supply interruption, no matter how unfounded they may be, sent prices for Texas tea through the roof. On this round, oil clearly fell out of the "RISK ON"/"RISK OFF" model.

Not only do assets show their true colors in conditions like this. They also demonstrate their character. Look at the gold/silver ratio. Historically, silver (SLV) moves twice as fast has gold (GLD), with double the beta. Since the last low, it has doubled gold's move. When the barbarous relic gained 17% from the recent $1,175 low, silver roared some 36%. Thus the relationships have been maintained.

How did my own model trading portfolio do? I took it on the nose with my oil short, moving from a profit to a loss. But my short positions in the yen and the euro did well, nearly offsetting those losses. So overall, my 35% year to date performance has been protected, and the volatility kept down. This is whyy I always try to run a book of counterbalancing "RISK ON" and "RISK OFF" positions, or stay very small. You should do the same.

Oil Has Suddenly Become Hot

Which One Did You Say I Should Buy?

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Wow! That was some speech! Secretary of State, John Kerry, was certainly rattling the saber last night when he laid out the irrefutable evidence confirming the use of chemical weapons in Syria. Defense Secretary, Chuck Hagel, then upped the ante by asserting that US military forces are ?ready to go.? Oil (USO) hit a two and a half year high at $109, and gold (GLD) finally resumed its ?flight to safety? character by spiking up $30.

I happened to know that the Joint Chiefs of Staff have been war gaming for Syria for over a year now, and have presented President Obama with a list of graduated levels of response. What is new is the movement off assets to the immediate area, like a major carrier task force, which will park 100 miles offshore in the Eastern Mediterranean for the foreseeable future.

My pick is for a no-fly-zone, which the administration should have executed a long time ago. It is cheap and can be implemented remotely, with no risk of casualties. Drones will come in useful too. F-16 fighters now carry smart missiles with a 70 range. If a pilot in Syria takes off, then poof, they?re gone in 30 seconds.

Although the financial markets are expecting immediate action, we may not get it. When traders started speculating about military strikes, you want to run a mile. Obama is first and foremost a pacifist and needs more than overwhelming evidence to fire a single shot. He even hesitated over taking out Osama bin Laden. He also is a lawyer, so he won?t move until the needed international legal framework is in place, such as a United Nations resolution.

The great irony in all this is that the current crisis has absolutely no impact on the actual supply and demand of oil. Syria doesn?t produce any. It is a net importer of oil. All of the other major crude producers in the Middle East are backing US action, except for Iran, a marginal producer at best. Pure emotion is driving the price here. That is why oil and gold have been going up in tandem, until recently a rare event.

If anything, there is a severe imbalance developing in the crude markets that will soon send prices sharply southward. Thanks to a triple barrel push of improving economic data, Egypt, and then Syria, Wall Street has built up a record long in the oil futures market of some 1.9 million contracts. That works out to an incredible 95 days of daily US consumption, or 256 days of imports. That is a lot of Texas tea sloshing around the books of hot handed traders.

We are just coming to the close of the strongest driving season in 31 years, and demand will soon ebb. And guess what? The economic data is now softening. Unwind just a portion of the speculative long position in oil, and we could quickly return to the $92-$95 range that prevailed before the multiple crisis.

Don?t just stop at oil. Syria?s president, Bashar al-Assad is setting up a buying opportunity for the entire range of risk assets, including longs in US stocks and short positions in bonds, yen, and the euro.? If we get no Fed taper in September, as I expect, it could be off to the races once again.

Meet Your New Trading Strategy

Meet You New Market Timer

Why I Sold Oil

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I think that oil peaked last week with the Egyptian Army?s ferocious and bloody attack on the Muslim Brotherhood. I hate to sound cynical here, but count the daily bodies in the street, which has been trending down sharply since Thursday?s, 1,000 plus tally. Fewer bodies mean lower oil prices.
This has most likely broken the back of the fundamentalist opposition movement for at least the time being, which has accounted for the $20 spike in oil prices over the last two months.

This returns us to the longer term fundamental trend for oil, which is sideways at best, and down at worst. The US is flooding the world?s oil markets with energy in all its many forms. The driver here is American fracking technology, which will continue to upend the traditional energy markets for decades to come. It?s just a matter of time before fracking goes mainstream in Europe, especially in the big coal countries of Germany, Poland, and England. Then they can thumb their noses at Russia, a major gas supplier over the last thirty years. China will follow.

In a crucial news item that wasn?t reported nationally, the California legislature voted down a measure to ban hydraulic fracturing in their state. It was defeated in a democratically controlled body. As the Golden State is the most anti energy state in the country, this gives the state a flashing green light to move forward against environmentalist opposition. There is a ton more of new supply coming. This is what the weakness in the price of natural gas is telling you (UNG).

We also received a new negative for oil this month, the collapse of the emerging market currencies, stock markets, and bonds, especially the Indian rupee. This reduces their international purchasing power in US dollar terms, thus raising the cost of oil in local currency terms. You see, oil is priced in dollars. As the emerging markets have seen the largest growth in demand for oil in recent years, this can only be bad for prices.

In terms of my own trading portfolio, I want to have a ?RISK OFF? position, like an oil short, to hedge my two existing ?RISK ON? positions in the Euro (FXE) and the yen (FXY) shorts. US stock markets could be weak into September, and they will take oil down with them.

The energy inventory figures released on Wednesday were another tell. Oil came in line with a 1.5 million barrel weekly draw down. But gasoline showed a precipitous 4 million barrel drop in supplies, meaning that more people are driving to their summer vacations than expected. Texas tea should have rallied at least $1 on the news. Instead it fell $1.50. It is an old trading nostrum that if a contract can?t rally on surprisingly positive developments, you sell the daylights out of it.

Below, you will find another chart that you should wake up and take notice of, the Powershares DB US Dollar Bullish Index Fund (UUP). Commodities traditionally are weak when the dollar is strong. Both the chart and the fundamentals suggest that we are close to a multiyear low for the greenback and are about to enter a prolonged period of dollar strength. This is also grim tidings for oil.

Finally, there is that last resort, the charts. Check out those for the (USO) and oil and it very much looks like we have a triple top in place. That is the straw that breaks the camel?s back. Time to sell.

The only way I am wrong on my oil call is if the Chinese economy is about to take off like a rocket. They are the marginal big swing player in this market. But there is absolutely no sign of that happening in the economic data. If anything, the collapse in emerging markets suggest that conditions in the Middle Kingdom are about to get worse before they get better.