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Oil, Housing and the Dollar

by: John Verke August 17, 2008 | about stocks: CVX / DHI / ITB / PHM / TOL / URE / USO / VLO / XOM    

John Verke

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Given the three false bursts of the oil bubble since oil started its ascent in mid-2007, investors are skeptical about the recent fall in commodity prices.

The main reason is that oil prices seem to move very quickly in large percentages, bringing with it the opportunity to erase a month of declines within two or three days.

If you have been trying to short the United States Oil Fund (USO) over the last 6 months, you probably know what means. However, I think oil’s descent to more reasonable levels is the real thing this time around due to the significant rally in the dollar.

The main underlying assumption of this argument is that despite oil being a very important and highly popular commodity due to media coverage, oil markets are considerably small compared to the stock markets, and even smaller compared to the currency markets.

CNBC reporter Bob Pisani, whose commentary I find highly insightful, points out in one of his blog entries that the whole oil futures market can be controlled by roughly 25 billion dollars.

Theoretically that means if you put 25 billion dollars into the oil market, you can take a barrel of oil not to $200, but even $1.000. Of course, this is a practical impossibility, but you get the point.

In contrast, the volume in the currency markets is measured not in billions b,ut trillions of dollars in a single day in a single currency couple.

Therefore, unlike the oil markets, it’s virtually impossible for a couple of big boys to gather in a room and put the Euro/Dollar exchange parity wherever they want. (Yes, I know that Soros did this in the 90s, but that situation was supported by economic fundamentals and wasn’t only speculation. In addition the financial market volumes were much smaller back then.)

This time around, the dollar’s rally is substantial enough that I think there is a global call to the end of the correction period in the US markets. We also have the classic formations of a recovery (and as I might say the start of the next bull market), as financials and housing stocks are gaining ground. When looking for a market bottom, one must realize that the stock market is very forward looking.

The housing stocks will have recovered almost half of their losses in the last two years before the data starts to show an improvement. If you want to catch the train this time, you should definitely be long the iShares Dow Jones US Home Construction ETF (ITB) and Ultra Real Estate ProShares ETF (URE).

That being said, I think oil is unlikely to go lower than the $80-$90 dollar range. The reason is that the rise in oil before this last ascent in 2007-2008 was unproportionate low compared to the amount of wealth created through the real estate boom and the rise in the stock market.

In other words, although $4 gas is frightening, given the rise in wealth in this last bull market, people would be comfortable with a $3.25 - $3.50 range. A lot of  oil’s fate will also be determined by the elections, and so on.

Based on this, being long the refiners like Valero (VLO) and Exxon (XOM) might be a good bet also, as falling oil increases their margins, but I think the housing stocks will be the next momentum trade and are a better choice.

Disclosure: Author holds long positions in URE, TOL and DHI

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This article has 9 comments:

  •  
    Aug 17 05:12 AM
    Nah...we are tired of dark age fossil fuel too much of a headache and too polluting, we prefer new age technology i.e. electricity, hydrogen-water at least to dirve a car.
    Reply
  •  
    Aug 17 07:17 AM
    John you are right on. Their is no shortage of energy. Capitalism works!!

    We had no bear (very close though) and no recession. How can so many people be wrong?
    Reply
  •  
    Aug 17 08:45 AM
    I totally agree about now is the time for getting into housing. It will be coming back very strong soon. Just need to make sure you are in with the right stocks or funds.
    Reply
  •  
    Aug 17 09:43 AM
    Housing will get much worse as by mid-2009 as unemployment grows unless we fundamentally deal with Peak Oil issues. World Oil Exports (amount of oil that can be purchased) peaked in 2005 at 46.4 million barrels per day. The deficit since has grown to 3 times the size of the 1973 Oil Embargo deficit.

    We are still staged for oil supply shocks, seekingalpha.com/artic...

    Re-tooling transportation is necessary seekingalpha.com/artic...
    Reply
  •  
    Aug 17 12:45 PM
    Whew!--Thanks Bill for reassuring me I was still on Earth.
    The Author has a right to adopt views from the third ring of Saturn--but---when the commentators join him in space, I have to pinch myself!.
    Reply
  •  
    Aug 17 12:59 PM
    I don't confuse future performance of homebuilder stocks with real estate prices. They will perform with opposite results over - at least - the next year or so.
    RE.porter
    Reply
  •  
    Aug 17 01:07 PM
    25 billion dollars can control oil futures? You have no idea how trading works.
    Reply
  •  
    Aug 17 07:53 PM
    I wouldn't be surprised if all those greedy mortgage manipulators, after losing their shirts in housing, moved into oil to get their money back.

    If FNM and FRE are to be bailed out, take it from the "oil nouveau" Their the same people!!

    Instead of robbing Peter to pay Paul, we can Rob Paul!

    Did I say Ron Paul??

    God, I wish I had some of that old money.
    Reply
  •  
    Aug 18 11:18 AM
    Controlling oil fitures with $25 billion I have my doubts.
    Reply
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