Gustav and Its Impacts

So much focus on Gustav, the tropical storm-turn-hurricane category 5 when it hits the Gulf of Mexico. What does this mean to Ultra Oil&Gas ETF (DIG) ,Ultrashort Oil&Gas ETF (DUG) and the US Dollar currency?

Let's zoom into the ETF story first.

While this news may be bullish for the Crude Oil commodity itself, unfortunately, not for its refineries.

• So far in my articles, I have always assumed direct correlation between crude oil prices and its benefits to oil & gas companies. Higher energy prices translates to higher profits, and vice versa. So far, this direct correlation has been true due to the fundamentals of economics. The situation is direly different now.

• If you examine closely the components of DIG & DUG, both are either long/short the oil & gas companies, NOT the actual oil&gas commodities. As such, damages to oil&gas facilities which belongs to the refiners will adversely impact its production capacity and incur losses on the part of the companies.

• While the crude oil prices will surely rises in the case of reduced production capacity, the oil & gas companies are unable to profit from the rising oil prices due to the damages to their oil rigs which harvest the expensive oil (damage assessment during Katrina - similar category hurricane in 2005 - is huge and is available at this link)

• This is part of the reason why you've seen the DUG rises while crude oil price rises. Market is finally getting the sense of this sentiment.

• In short, Ultrashort Oil&Gas ETF has more potential upside and the reverse for its long counterpart.

What does this have to do with the US Dollar ?

• Precisely the point, NOTHING.

• The market has been so attached with the fact that rising crude oil is attributed to the weak dollar and the stronger USD will therefore cause prices of oil to go down. This correlation will be broken soon.

• USD fundamentals remain strong (more due to external factors than internal) and will continue to do so unless there are signs of reversal in ex-USA economies, especially the Euro-zone.

• Perhaps, this is a new environment where the strengthening of USD will go alongside the strengthening of crude oil price.

Crude Oil Trade... The Starting of the End?

I have been monitoring the Oil & Gas ETFs (especially Ultra & Ultrashort Oil & Gas ETFs)* to gain more understanding of the interest in Oil & Gas sector.

The following graph reflects the market cap of each ETFs which I have been tracking since 5th August.

Notice the increasing market cap of Ultra Oil & Gas ETF as Crude Oil price drops and reverse for UltraShort Oil & Gas ETF.

The above chart shows the decreasing interest of short-oil trades. However, does this mean that money is pouring into the long-oil counterpart? We'll answer this question in the next section below.

Keep a watch out on your short-oil trade and possible exit once the market cap is near balance. Should the rate of change stays, it should roughly be in the next month or two.

To answer the question above: "Does this mean that money is pouring into the long-oil counterpart?", let's examine the following stacked chart which shows the combined/total market cap for both the ETFs.

Notice the declining trend? People are definitely pulling their money out of any oil & gas trade and putting it elsewhere...

Is this a sign for equity rebound as money is being pulled out of these trades and poured onto equities? Or money waiting at the sideline?




* I chose these two ETFs as they are the ones directly related to what I invested in. There are so many other ETFs that does similar trades and thus readers discretion is advised. This analysis is meant as a "representative" of the trade and not the collective whole.

Crude Oil Bear Ended???

Crude Oil rises from $112 to $122 overnight. Is this a sign that the commodities bear is over?

In my opinion, NO. There are a couple of reasons which I think is in play:
1. Profit taking. Recent oil bear has been on a sharp drop over period of just a month (record high of $147 was on July 11th). So, a correction to the upside is normal and this is probably the period where the shorties (people who short oil) take profit as crude has been unable to break the $111-$112 support.
2. Reaction to the Russia-Georgia conflict is well overdue. When the news of Russia-Georgia conflict emerged, oil didn't spike up and this previous reason aggravate the correction.
3. Fundamentals for oil bear are still intact for the moment. UK re-affirms one such fundamental in its stagnant GDP reports growth for the past quarter. It is most likely to enter recession in the next quarter. With that news, USD will strengthen relatively against European currencies which causes USD-denominated commodities prices to drop. The story on worldwide demand destruction is also unchanged.
4. Warren Buffet's view on USD. He just appeared in CNBC (just at the point of writing) and said he has no bets AGAINST USD. His neutrality is a change of course over his previous bearish view on the USD and re-affirms the USD's upside potential.

Conclusion:
Shorties, stay on course.

Bullish USD Outlook

This sentiment is helped by the following factors:
1. Dropping commodities and gold as they are mostly priced in USD
2. The most important factor is: the shift of concerns from high inflation to slowing economic growth across the various central banks, i.e. ECB (European Central Bank), RBA (Reserve Bank of Australia), BOE (Bank of England)
3. The shift of concern causes those central banks to start holding interest rates for their currency with the strong possibility to cut rates soon (this is reflected in interest rate futures for AUD which is pointing to a 25 basis point cut in Oct 08 and another in Jan 09).

I have been monitoring the following 2 ETFs to understand the USD-buying interest:
1. PowerShares DB US Dollar Index Bullish Fund (AMEX:UUP) has market cap of ~USD 575 million (as of 12 August 2008), which represents 6x the interest in the bearish counterpart. As of the point of writing, the market cap has grown to ~USD697 million (a 20% increase in just 3 days*). Examining the chart of this ETF, this instrument had been consolidating for 4 months from mid-March till mid-July while testing low of ~USD22.30 at least 5 times. The resistance at USD23 and USD 23.30 has been broken to the upside. Future break out at ~USD 24 can test the next resistance at ~USD 25.
2. PowerShares DB US Dollar Index Bearish Fund (AMEX:UDN) has market cap of ~USD 95 million (as of 12 August 2008) and has dropped to ~USD 72 million (-24%) in just 3 days. Looking at the chart of this ETF, it has broken the support of ~USD 28.50 which is heading towards support of ~USD 27 and breaking this could test further support at the range of USD25.80 - 26.40.

One can argue that the increase/decrease in the market cap explained above is due to the changes in ETF prices. However, if we examine the absolute prices of the ETF in the same period as above, they're in the range of USD23.66 - USD24 (~1.4%) for the AMEX:UUP and USD27.00-28.09 (~4%). Clearly, the larger market cap movement represents new/lost substantial interest in respective ETFs.

However, there's still possibility that this sentiment can reverse, in my opinion:
1. Commodities stops dropping and starts rising again
2. Other central banks starts focusing on high inflation (due to point #1)

Conclusion:
Strong possibility of continued upside move of the USD against all major currencies.

PS: Invest at your own risk.

* I know that I need to monitor this over longer period of time. As I just started monitoring on 12th August 2008, only this information is available for me at the point of writing. This is intended to show the tremendous increase of the USD buying interest at this period.

Indonesia's JCI to trade from 1625 to 1800 towards end of 2008

Crude oil gains ~50% YTD, partial removal of subsidies in Indonesia, high inflation rate, dropping commodities prices. So, what are the real factors that makes Indonesia's JCI to trade between 1625-1800 which is a 18%-26% drop to current level of ~2200 ?

Want to know the answer? "ALL" is the answer as it chains from one even to another before we finally see the effect on the Jakarta Composite Index (JCI) index.

Let me break it down one by one why this is so:
1. Crude oil gains ~50% YTD has put tremendous budget constraints on the budget of Indonesia government to run its economy. The government has finally decided to pass some of the higher price to its consumers. This has created high inflation environment in Indonesia.
2. Partial removal of subsidies was caused by the high oil price described in previous point. The key point is the "partial" where only a percentage of the subsidies is removed, not everything.
3. High inflation rate, in general, erodes corporate profits as prices are higher and thus costs of production. The end result of this is lower profits which translates to lower stock prices.
4. Dropping of commodities prices has not helped lower inflation. It reduces earnings of the commodity-producer-heavy index and therefore eroding profits and thus share prices. Dropping prices also does not help lower inflation either: gasoline costs only Rp. 6,000 per litre in Indonesia (which is equivalent to US 65 cents or SG 92 cents) even after the partial subsidy removal. Just for comparison, gasoline in Singapore is SGD 2.20 when oil was at record price. Even with oil at USD80, gasoline that costs US 65 cents is still very cheap and therefore still put pressure on government budget, thus high prices is here to stay and thus high inflation.

The figure 1625-1800 is derived from the 5 year chart of the JCI and represents the support level of the bull market trend that has formed since mid-2003.

Short Oil - The Trade for H2 2008 ?

Crude oil hit record high price of US$147 twice and can't seem to break beyond that and starts getting bearish.

There are a few fundamental reasons that markets have in mind that makes oil to drop... at least for now and probably till end of 2008:
1. Significant demand destruction worldwide. There are no exact number to justify this, however, developing countries like India and Indonesia (which together accounts for 20% of total world population - according to this site as of 2007 estimate and net importer of oil as of today) whose governments lifted oil subsidies due to budget constraints, helped to kill some demand from these developing worlds. As for the USA, you know the sub-prime that leads to housing problem and credit crisis, all these helps to reduce demand in the country.
2. Recession risk in Europe & Japan. With Spain and UK are entering recession (but not in recession yet) with strong possibilities of other European countries following suit, this will help curb potential demand in Europe. Japan helps to contribute to this risk and thus demand destruction.

Analysing the following 2 ETFs will help understand the actual interest in shorting oil:
1. Proshares Ultra Oil & Gas ETF (AMEX:DIG) has market cap of USD 120 million and this represents just 5% of the market cap of its short counterpart. Technically, it has formed double top during the time oil was at record price of USD 147 and this is a good indicator for a change in price direction of this ETF.
2. Proshares UltraShort Oil & Gas ETF (AMEX:DUG) has market cap of USD 1.99 BILLION and this represents 16.6x the interest in the long counterpart. This indirectly means that for everyone that bets oil will go up, there are at least 16 others who bets it'll go down. Technically, the reverse of the former ETF has happened here: double bottom which is a good indicator for a change in price direction of this ETF.

I personally feel that this trade is good only till roughly end of the year or when oil drops below the USD 100 mark.

Conclusion:
Short oil and hold till end of the year or when oil drops below the USD 100 mark.

PS: Invest at your own risk.