Is this Market Recovery Real?

One year ago today, Sept 3, 2008, the DJIA closed at 11,629. Today, Sept 2, 2009, it closed at 9,281. In March of 2009 the DJIA hit its “crisis” low of a little below 6,600. So, if you bought an ETF on the Dow at its low point, you would have made 40% on your money in 6 months. Was the March low an exaggeration or is the current bull market way overbought. The consensus seems to think we are in line for a pullback.

Oil, after reaching a high in July of 2008 of $147.02 a barrel, fell to $33.87 on December 21, 2008. As of yesterday it closed at $68 dollars a barrel. If someone had invested in oil in December 2008 at $33.87 a barrel, they would have made a return of about 100%. Not surprising to hear about the oil trader for Citibank who is due to receive a $100 million bonus for his trading in 2008. Is it possible that demand for oil could have fluctuated so much in one year?

I am a casual observer of the markets, I have no positions at all right now and for me it is a purely intellectual exercise to try and predict where they are going. Many market pundits are saying that this fall will come a major correction. Some talk of a “secular bear market”, I love that expression. It means a long term bear market, apparently, the last one we had was between the early 60’s and early 80’s. What would a religious bear market look like?
So let’s have some fun and spend 20 grand in funny money and make the obvious bet, than look back afterwards and see what happened. This is a mindless, unoriginal wager. First, we will by a puts on a Dow ETF, in this case DIA. A Dow ETF (Exchange Traded Fund) is a fund that represents the 30 stocks in the DJIA. It is a simple a way to gamble on the Dow, Dow goes up you win, goes down you lose. We are going to buy 75 put contracts ($10,350). Each contract is for 100 shares and costs $138. For each contract, we control 100 shares. A put is the right to sell, so for $1.38 we have the right to sell a Diamond ETF share at a strike price of $87 from today until the last week in October. Today, Sept 2, 2009, DIA closed at $92.83. So we don’t make any money unless DIA drops below $87. For example, if the share price goes to $80 before expiration, (third Friday in October, we have 44 days left) we sell our shares for $87 and buy them at $80 and make $7 a share, which would give us a nice profit of $42,500

Let’s do the same thing for oil. There is an ETF for oil, with the symbol OIH and it mirrors the price of oil. We will by around 10 grand of puts, the Oct 09, 90 put, $1.86 per share, or $186 per contract (100 shares). OIH closed on Sept 2, 2009 at 102.32 (Oil closed at $68 dollars today.) We will buy 50 put contracts, $186 a contract ($9,300). We don’t make any money until the price goes below $90. This contract expires the same day as the DOW ETF, third Friday in October, so we also have 44 days till expiration.

This trade is so obvious I can’t resist it. I am so sick of reading the NY Times, so bland and boring, a barn for sacred cows. (Of course, ten minutes after writing this I read a fabulous article by Paul Krugman on macro economic theory, has to be the best thing I've read in NyTimes in years, go figure How Did Economists Get It So Wrong? ) Lately, the only thing I can read are crazy market newsletters that claim the end is near. There is one I love, Taipan Daily, both writers are clever, articulate and iconoclastic. They actually say things, not just spew aphorisms, so I guess the NY Times won’t be hiring them soon. And all these market doomsayers are claiming a massive crash this fall. You have to believe that they had their generational collapse last fall, but they continue to think the worst is coming.

So what causes oil to go from $147 to $34 and back to $68 a barrel in a period of 13 months? Supply and demand? Ha, that is a good one. Oil supply and demand changes by a few percentage points a year, what we see in oil, and I also believe the DJIA, is pure speculation. Speculation is supposed to be good, finds the correct price when there is enough information, so what is the correct price for a barrel of oil? This is really a fascination topic if you consider the future prospects of Peak Oil. Where those price fluctuations really a representation of the collective confusion as too how much oil we have left?

From a 60 Minutes piece.

“In a five year period …the amount of money institutional investors, hedge funds, and the big Wall Street banks had placed in the commodities markets went from $13 billion to $300 billion. Last year, 27 barrels of crude were being traded every day on the New York Mercantile Exchange for every one barrel of oil that was actually being consumed in the United States.”

If you think about that, only 1 in 27 barrels was actually bought for consumption, the rest for speculation. How could supply and demand have any effect on the final price?

Dan Gilligan, the president of the Petroleum Marketers Association further explains.

“Approximately 60 to 70 percent of the oil contracts in the futures markets are now held by speculative entities. Not by companies that need oil, not by the airlines, not by the oil companies. But by investors that are looking to make money from their speculative positions.”

But when congress asked Lawrence Eagles of J.P. Morgan what was driving the volatility he explained. "We believe that high energy prices are fundamentally a result of supply and demand,"

How long can we let these people speculate on our natural resources? Has anything really changed since things blew up a year ago?

“The percentage of U.S. homeowners who owe more than their house is worth will nearly double to 48 percent in 2011” From Reuters. So, either I am missing something or all that garbage mortgage paper that no one wanted a year ago is still worth nothing.

"If one considers the people who would like a job but have stopped looking -- so-called discouraged workers -- and those who are working fewer hours than they want, the unemployment rate would move from the official 9.4 percent to 16 percent”, said Atlanta Fed chief Dennis Lockhart.

“In July, more than 360,000 U.S. households drew a foreclosure filing (i.e., notice of default, auction, and/or bank repossession), which represents a new monthly record since RealtyTrac began issuing its updates in January 2005” From Consumer Reports.

And commercial real-estate “Total delinquency rate reached 4.1% in June, 2.2 times its March level and 3.5 times that in December. Delinquency rates are likely to soar higher over next 24+ months on billions of dollars of pro forma loans that never stabilized and resetting partial IO loans” From Deutsche Bank. Many say that this is just the beginning, and that the 3 trillion dollars in commercial real estate debt will be the final blow to the banking sector.

What about credit card debt, how are the big banks treating us now after we bailed them out to a tune of God knows how many billions of dollars?

“Fitch Ratings reported Tuesday (July 2, 2009) that defaults on credit cards hit a record 10.4 percent last month amid rising unemployment, falling home values and reduced wages. Total losses on loans that credit card companies have given up on collecting have risen more than 62 percent from a year ago, according to the credit-rating agency. On Tuesday, the Financial Times reported that Citi raised interest rates on 15 million cards co-branded with companies like Sears and Macy’s. Cardholders who did not pay off their entire balance saw their credit card rates increase by an average of 24 percent, according to research by Credit Suisse cited by the FT.”

I don’t have an MBA from Harvard, I never worked on Wall Street, I never made a million dollar bonus. But one of the unfortunate things about getting older is that you stop believing the “talk” you hear from folks high up on the food chain. My experience is, the higher you go up, the more ____ you hear. 'Green shoots', 'Blue Dogs', I have really heard and seen enough of people blowing smoke into interesting places. I see speculators making fortunes on oil and stocks, and I also see that the real value of everything is about to take an enormous crash. Will it happen in the next 44 days? Who knows, but it will happen. Check back and we will take a look at the box score.



  1. OIH is NOT based on the price of Oil.

    It is a basket of stocks of companies that serve , or are in the oil business.

    Drller, exploration, and distribution companies etc.

  2. but my friend their revenues are pretty much tied to the end product, which is Oil here :)