Is it time to short oil and commodities?

Although there has been a global increase in demand for oil and other commodities, that increase in demand is relatively tiny compared to the huge jump in oil and commodities prices. And there is clearly no shortage of oil. And demand for oil from the U.S., the largest consumer of oil, is actually declining. Speculative buying of oil and commodities really is behind the vast bulk of the big price leap. Yes,this is a true "bubble". Global demand for oil will continue to grow, but the speculative bubble is fueled by investment funds, and even the richest of them will eventually be "all in." Timing is everything when judging the state of a bubble. The oil "bubble" looks and acts a lot like the old NASDAQ dot-com bubble in a lot of ways. The future for the Internet and Web was indeed very bright and actually does continue to get even brighter, but the hype greatly exceeded the reality. And that is where we are with oil, where the hype about demand is vastly greater than the reality of demand. The big question is whether we are in the "1999" of the oil and commodities bubble or in the early "2000" stage. Oil could continue on up to $150 and $200 and beyond, but are the investment funds that have fueled the bubble really standing by to dump vast new piles of cash into the commodities markets, while a wide range of government investigators are actively probing just such activity? Oil and commodities may be in more of a short-term "trading frenzy" right now, with the focus on very short-term trading of volatility rather than taking on large new longer-term speculative positions. I am sure there is a fair amount of this kind of trading going on, but whether it was the main source of the jump this past week is unclear.

So, the question of the day is when will it be "safe" to successfully short oil and other commodities?

As I said, timing is everything. Some people lost a lot of money shorting NASDAQ and dot-com late in 1999 and early 2000, but they really were fairly close to judging the market top in March of 2000.

Personally, I do not have the capital to short anything in quantity, especially with the prospect of margin calls, but buying "put" options is a possibility. The only problem is that they are probably getting pricey since a lot of people have this same idea. The main downside risk with a put option is that you could lose all of your money if we really are in 1999 rather than March 2000 for the oil market.

There is one safe way to short, namely "against the box", where you short a security that you actually own. That means that there is no chance for a margin call since if the trade goes south you simply surrender the underlying security, with your only loss being the failure to make money on the increase in value of the security. I did this a few times way back in the 1980's. I'll have to check up on the current rules. At a minimum you would have to wait three days for the "buy" trade to settle before you could execute the short against the box trade, I think. Better to buy on a sharp decline, and then maybe pick up the next spike upwards before opening the short position.

I do believe that some of the recent upward spikes in the price of oil were due to short covering layered with piling-on by momentum speculators. That kind of behavior will continue until large investment funds begin liquidating their large investment positions. Some big Wall Street firms are also beating the drum for $150 oil, which is within reach, so I suspect that we could see $150 oil in the coming weeks, fueled primarily by short-term traders, short-covering, and a loyal band of diehard momentum investors.

Besides the activity of investment funds, the big wildcard is the increasing activity of government regulators., especially in a big election year where the Democrats are developing a lot of mementum for "change." I strongly suspect that there will be big changes governing speculation in commodities, but it may take months or longer before "rules" get drafted and then eventually put into effect.

At some point I may make a small, symbolic bet on declining oil, but I certainly do not feel comfortable doing so today. Maybe I will become more "inspired" when oil hits $150 or $175. Or maybe the day the Democrats formally nominate Barack Obama will be a great symbolic turning point. No hurry. Great investments are never made in a hurry.

-- Jack Krupansky