Oil prices have rallied hard over the past month or more, lead by gasoline. The oil markets now are starting to lose some momentum due to building motor gasoline supplies and lower demand. The next two weeks, as we head into the July 4^th weekend, will be a key time frame for the oil markets. On a seasonal basis oil prices peak around mid July which is also somewhat of a peak to the gasoline season. Watch gasoline closely as a key indicator for price direction on crude oil.

In the longer term there are many schools of thought that oil prices will move higher. The IEA warned of a possible energy supply crunch by 2014 if global economic growth reaches 5% in the next few years. The WTI spreads seem to agree with this forecast. The price curve for WTI futures is very steep with prices much higher as they move forward in time. The December 09 to December 2016 spread has been trading between -$13/bbl and -$20/bbl in the last two months which indicates that the futures market is looking for higher prices as we move forward.

If interested in learning how to trade this curve for higher prices stay tunes for future articles on this subject.

The oil markets are not driven solely by supply and demand factors. If this was the case oil prices would be closer to $30 and not sitting around $50. There is a lot of conflicting information which at times makes forecasting price direction more of a guest than applying logic based on fundamentals. Last week Goldman Sachs revised their 2009 Chinese GDP growth estimates upward to 8.3% from their previous estimates of 6.0%. The IMF came out with their growth estimates for China and reduced Chinese growth by 0.2% to 6.5%. This is a huge gap in demand estimates and ads to market confusion for forecasting price direction. Based on factors like this, oil prices look for direction from other factors such as the stock markets and exchange rates. The oil markets now play a number of roles other than just a major source of global energy. Oil and oil derivatives play a role globally as an inflation hedge, a dollar hedge, an asset diversification hedge and a geopolitical risk hedge. When these are all factored into price it is difficult to sell down oil below the low 40s.

Based on this logic, buying oil related assets on major oil corrections has been a consistent winning trade. I have played these sell offs by selling the front month, out of the money PUTs on the Oil Services HOLDRs (OIH). This ETF has been trading in a range of $65 for support and $87 for resistance since October of 2008. It is trying to close above $87 for a break out to $100.

Nothing has changed; I am still using the Hybrid Strangle Strategy, which is to sell Calls above resistance and Puts below support. Sell Calls into major rallies and Puts on sell offs. The range on the S&P is 830 to 670 on the down side with intermediate support at 730.

I am sticking with natural resource stocks on any pull back. Using options I will either being selling puts on correction of the OIH or buying covered calls on the OIH and other natural resource stocks. 

OPEC is due to meet in 5 days’ time. A consensus of estimates is that compliance is in the 81 to 87% range with March looking even better. The dilemma OPEC face is whether to make additional cuts in anticipation of further demand erosion and 2Q seasonality, so risking antagonizing world opinion or wait to see if the delayed cut backs remove the physical surplus and push prices higher. A key judgment is whether the market has factored in more cuts. There has been so much talk of further cuts that the chances are that it has, even if it may not have found them particularly credible. The need for more will be emphasized by reports from the EIA, IEA and OPEC itself this week all of which will make big reductions to their previous 2009 demand forecasts. The OPEC Secretary General is already warning that OPEC’s own report will take another 1 mbpd off demand, bringing the 2009 to 2008 decline to 1.6 mbpd. Since its December report, based upon which OPEC decided they needed a total cut of 4.2 mbpd, their research group has cut demand by an additional 1.53 mbpd. The logic of making another cut of at least 1 mbpd is very strong just to hold prices at current levels.

One organization always confident in its opinions of what OPEC should do is the IEA. It tries to be all things to all people whilst representing the interests of consumers and has a history of joining the chorus of alarmists. Its current mission is to warn the world that there will be a supply crisis by 2013 because of the impact of low oil prices on investment. At the same time it is pleading with OPEC to avoid making further cutbacks so that oil prices can remain low to stimulate the global economy. The inconsistency of their positions is something that we have often commented on. It has taken a long time but OPEC has at last been goaded into a response. They point out that investment decisions are based on price expectations and the longer prices remain at $40 bbl the less the chances that investments in new production requiring a higher price threshold will be made. The only thing both organizations agree on is that supply problems are mounting for the future.

A story came out today from Singapore that China was making a possible shift from U.S. Treasury Notes to oil. If this proves to be the case there will be a great amount of inflation in the future.

China is accelerating the build-up of its oil reserves to avoid the economic dislocations the country suffered in 2008 from fluctuations in the world oil price

China's National Energy Administration (NEA) recently released a plan to build nine large refining bases in coastal areas over the next three years, sources with the China Petroleum and Chemical Industry Association said last week.

The plan involves building three 30-million-ton refinery bases in three cities (Shanghai, Ningbo and Nanjing) in China's economically dynamic Yangtze Delta and six 20-million-ton bases in other coastal areas from Tianjin in the north to Guangzhou in the south. It will also facilitate major joint-venture refinery projects between Chinese companies and partners from oil-producing countries such as Venezuela, Qatar and Russia.

The refinery scheme is part of China's plan to bolster its oil inventories. The NEA announced at a national energy conference in early February that China will, in addition to the current four strategic petroleum reserve (SPR) bases, build eight new ones by 2011. The program will increase China's strategic crude reserve capacity to 44.6 million cu m, or 281 million barrels.

The country will also increase its refined oil reserve to 10 million tons by 2011, a source familiar with the stockpile plan told China Daily in February.

"China's attentiveness to its oil reserve capacity has grown in tandem with its rising dependence on imported oil," said Pan Jiahua, an expert with the Chinese petroleum society.

China, the world's second largest oil consumer, relies on imports for about half of its oil needs. It imported 178.9 million tons of crude oil in 2008, up 9.6 percent from the previous year, according to the National Development and Reform Commission. The country's lack of strategic oil reserve became a pressing concern during the steep oil price surge from 2004-07, when the Chinese government and state energy companies were left at a disadvantage compared to other major oil-consuming countries. China's national oil inventory reportedly covered only 21 days of its economy's need. Reserves in other countries, such as Japan and the United States, were enough for 100 days.

If you are looking for trade or investment ideas look to Energy Stock and Copper!!

1. Set a Bail-out point and use it- Set a stop loss point; this can either be the strike price or based on a certain price point of the stock.
2. Diversification- Maintain at least four different positions that are across different market sectors.
3. Write Puts and Calls that are at least 20% Out-of-the-Money- The wider the strike ranges the greater the probability of success. Select options that have the highest probability of expiring before the stock price ever gets close to the strike price.
4. Stay in the front month of expiration- You need time decay of the option to be at work for you. As an option approaches expiration its rate of depreciation increases.
5. Limit the number of contracts and have diversification- This will help limit losses if there is a major market gap open. Also, remember that stocks tend to have bigger moves to the down-side so carefully evaluate the put side of the strangle position.
6. Know your stock- Understanding the price movement of the underlying stock is very important. Knowing from experience how the stock moves within its price channel will greatly improve your ability to structure a strangle with the correct strike boundaries.
7. Maintain a Strict Stock/Option Surveillance Program- Watch the stock and option price like a hawk. If there is a major shift in the stock and its direction you need to be aware in order to react and take the right course of action. You may need to bail out of the position or take profits early. This surveillance program should also contain a continuous writing feature in order to keep your capital reinvested. By actively taking profits when they develop and reinvesting your portfolio will grow at a far faster rate than leaving it static.

This is further proof that we have found the bottom of the bear market. Whether the exact bottom was the S&P’s low of 839.80 on Oct. 10 or yesterday's low of 818.69 is academic. It is undeniable that once the market reaches those general levels, it deflects upward dramatically. On October 13, the first day of trading after the previous low was set, the market soared 11%. Today it was a 7% gain.

Earlier this month, central banks around the world—including the Federal Reserve—trimmed rates by half a point in a joint effort to encourage lending and thaw a frozen credit system. On Wednesday, the Fed announced a second cut of 0.5%, reducing the Federal Funds rate to 1%.

In the Fed’s statement Wednesday, the central bank indicated that rates could possibly go lower sometime in December, especially if the “downside risks to growth” persist and the U.S. economy continues to lose steam.

It’s too early to tell if this latest round of cuts will make any real difference to facilitate lending, but luckily these reductions are just one tool in the Fed’s bag of tricks. The bottom line is that the market responds well to rate cuts, as we saw in the 900-point run-up in the Dow the day before the FOMC’s big announcement, and the 250-point upswing just after the statement was released.

The Commerce Department released a report today that said consumer spending fell 0.3% in September. This news comes on the heels of another report that indicated belt-tightening consumers drove spending down in the third quarter by the highest rate in three decades.

This was to be expected, especially since layoffs are rising and it’s harder for consumers to get their hands on credit!

Since consumer spending accounts for 70% of total economic activity, it should come as no surprise that the third-quarter GDP estimate reflected a 0.3% contraction. Although this figure was better than economists had expected, it’s a strong indication that the U.S. economy is falling into a recession.

The outlook for greater spending in the near-term is bleak, and retailers are already bracing for a tough holiday season. Unless spending improves, the “R-word” could come to fruition. It’s a double-edge sword because it makes perfect sense that consumers would want to save money when expectations of a recession are widespread. But at the same time, the lack of spending sharpens the downturn.

A week ago, Fed Chairman Ben Bernanke hinted at a second stimulus program. It’s too soon to tell what form such a package might take, especially with the presidential election in less than a week. Like many policy decisions about the current economic crisis, any bailout package will have to be finalized after November 4.

Perhaps the most important aspect of the upcoming election is that the results will remove a tremendous degree of uncertainty from the markets. Investors will finally know once and for all who will be the next president and which economic plan will take hold.