The Oil Trade is No Longer a Slam Dunk

In last year’s Note 17 of The Kelly Letter, sent to subscribers on April 26, 2020, I wrote an article, “Cheap Oil Will Become Expensive,” from which:

“The solution to cheap prices is cheap prices. …

“In the case of oil, last week’s negative price and this era’s persistently low prices will create a production wasteland as small players go out of business and big players shut down infrastructure. This will eventually meet higher demand, be unable to satisfy it, and send prices higher again…”

The Kelly Letter is not a trading advisory. These days, the only plans I actively manage in the letter are my automated quarterly Sig plans. However, in the unique window of opportunity opened by governments pausing their economies, I could not resist mentioning that there was no way oil would stay as cheap as it became at the end of April 2020.

Among other ideas for participating in what looked like a slam-dunk oil trade, I offered ProShares Bloomberg Oil 2x (UCO $65 +79% YTD).

Since then, the price of West Texas Intermediate has risen 300% from $16 per barrel to $64, and UCO has risen 293% from $16.53 to $64.92. People who bought UCO in late April or early May 2020 are now past the 12-month short-term capital gains tax zone. Many wonder if now is a good time to sell.

In my view, the case for a dramatic spike in oil price has greatly diminished from a year ago.

Oil is back to a normal price range, as the world economy reopens slowly, not in a rush that might overwhelm reduced production capabilities. OPEC and other producers look ready for gradually rising demand—such as it will be—if not a surprise demand surge.

The US may well hit the roads this summer, but it’s 4% of the global population. Europe still frets over Covid, along with Brazil and India, and even Japan is implementing selective lockdowns. Australian airline Qantas delayed its international service restart from the end of October to the end of December. I doubt we’ll see a worldwide all-clear that overwhelms supply and production to create an oil-price spike.

On the other hand, it’s hard to imagine what would send the price of oil meaningfully lower in the near term. The global economy will reopen.

Therefore, and as usual in trading, an incremental approach is probably best.

If you own UCO, consider placing limit sell orders to gradually reduce your position. This is my schedule:

My UCO Limit Order Sell Schedule
–  –  –  –  –  –  –  –  –  –  –  –  –  –  –
25% of position $65
25% of position $70
50% of position Later

Many people who benefited from this oil-price speculation plan to move capital from it into 9Sig. This makes sense, as the two ideas exhibit similar risk-reward profiles.

Conclusion: The oil trade is no longer a slam dunk. It’s wise to gradually reduce a UCO position.