8/11/08 (Oil Short? FDIC Bailout? Richard Branson!)

Traders,

Last Friday saw a market rally with many surprises. At the core of the rally was the massive short covering in the dollar – which sent both the foreign currencies down, along with commodities. Even oil suffered in the face of the battle in Georgia with its 2nd biggest pipeline in the world. That was the sole catalyst for the massive rally across the board in equities – for it was not any economic, sector, or even company news that drove the market out of the range and through those resistance points.

This weekend I heard many thoughts and reasons for it, from Trichet’s talk about Europe economic slowdown, US bailout finding the bottom, to even it was the start of the Olympics. No matter how you slice it – the dollar saw some serious trading and at some point the short covering kicked big time.

Regardless of that – the Olympics have started and whatever your thoughts of China – the games have begun and it’s been pretty exciting to watch.

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Oil there and back again?

Oil also saw some interesting action over the last couple of weeks – as all the talk about speculation driving up the market – it was actually a massive SHORT oil position by SemGroup that was forced covered from the 120 range and helped drive prices into the 140 area the losses are rumored to exceed $3 billion and the energy trading firm has filed bankruptcy. After the position was closed out the prices retreated back down. How – much was the run from the 120s to the 140s was because of this massive short position covering? Rumors as to the size of the short positions exceed 100 million barrels of oil (more than are consumed by the world on a daily basis).

An energy trader also told me about some interesting action from the institutional side as far as future hedging. He said that many of corporation hedging (which had inverted vs. spot purchasing) slow down by the beginning of the 2nd quarter. Many of these firms (airlines, shipping, energy) have pre-hedged their positions for the next 3-6-12-18 months. They “over” hedging in futures by the firms have slowed for the summer – from a combination of already holding enough future positions coupled with a drop in consumption. However – expectations are for a 3rd and 4th quarter “over” hedging to ramp again – as these companies do NOT want to have to rely on spot prices (buying when needed) as many of their future contracts come due.

Expectations? Well – between the SemGroup blowout from a massive short position that forced a massive covering – coupled with companies “over” hedged positions – oil prices between $100 - $125 for the rest of the summer and then possibly another ramp in the mid 3rd quarter to 4th quarter – as firms re-hedge going into the winter season.

There is definitely some volatility going on – between short-covering, over-hedging, Middle East, and now Georgia. This morning – CNBC was reporting that the Georgians have accused the Russians from TRYING to BOMB the pipeline. Note – that is the second largest pipeline in the world and is the artery to Europe.

Oil is up small this morning - $116 – after the big sell-off.

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FDIC to run out of money?

Between IndyMac and 7 other banks – the FDIC has already used up over 17% of their insurance funds and has started to raise premiums (a new burden for those that have not failed.) IndyMac being a whopper (3rd largest failure in history) – is going to cost FDIC between $4 to $8 billion (which is expected to be about 15% of the fund). Just like with taxes, those banks that are in the “black” are having their premiums raised (on FDIC insurance) to pay for the mistakes of the failed banks.

The “problem” bank list has grown in the 1st quarter by 18% to include 90 banks (note IndyMac didn’t make the cut – and many are asking how accurate is this list). A new revised “problem” bank list is expected this month. While it (currently) doesn’t look as bad as the Savings-n-Loan crisis of the 80s – which pulled $6.9 billion in 1988 – with IndyMac alone, if the high estimates are accurate – that alone would exceed the entire SnL crisis.

The FDIC is REQUIRED to shore up their fund when the reserve ratio (balance divided by the insured deposits) – slips below 1.15% or forecast to fall below that in 6 months. Well that ratio is getting close at 1.19% in the first quarter and IndyMac may push it down at the very least another 9 basis points (below the 1.15%). It looks like they are going to need to start raising money – now – and quickly.

Premiums had been 5.4 cents per $100 of insured deposits – a new rate has yet to be determined.
Will Bernanke let the FDIC come to the Discount Window too? Who knows – but if one bank, IndyMac, can take down 15% of the fund and more are expected on the expanding “problem” list – how much will they have to raise premiums to make up for the loss? Additionally – since the very banks they are insuring are paying those premiums – as more fail – they collect less in premiums. A vicious cycle indeed. I am sure Ben and his expanding powers are at the ready.

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British Airways and American Airlines AGAIN?

Sir Richard Branson wrote a letter to the two candidates warning about the possibility of a British Airways and American Airlines merger. He warns of a possible monopoly on Atlantic flights – which are currently dominated by the two. British Airways has tried in the past – but regulators made the same accusations that Branson has made and made the sticking point that British Airways would have to drop flights/hubs if any merger were to be approved. In the past British Airways has backed down – but the rumors are out that they plan to make an announcement as early as this week.
Why try again if they have to give up flights and hubs? Well – with the weekend economy and fuel prices – they just might be willing to make that concession (something they would not of budged on in the past.)

Expect to see some action and volatility in the airline sector – watch these two stocks – they are now in play. With fuel prices coming off some and the dollar seeing a rebound – this could get ugly and messy very fast.

Traders come and play – investors stay away.

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Futures Pre-Market

The futures are up, but below fair-value after a pullback in the after-market on Friday. There is a hidden volatility this morning – you can almost feel it. The ARB traders don’t know if they should be buying futures to short the basket (since they are underwater) or short futures after the big run on Friday. I think they will want to sit on the sideline and wait for the equities to open up first before taking too big of a leg.

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Support / Resistance

Wow – ripping through those numbers like butter – right after a retreat. One thing is for sure we are living in the year of volatility. It’s expiration week to boot – so anything is in the cards.

INDU 11,600 / 11,800 (I am giving it a fairly narrow gap to test. These areas are to GET FLAT ONLY! 11,800 is where we broke off hard in late June and 11,600 is the peaking resistance since then. While both 11,500 and 12,000 is in the cards – I think getting flat in the 11,600 and 11,800 area is the safe bet. Who knows 12,000 or 11,500 is both fairly realistic this week.)

NDX 1900 / 1950 (Another area to get flat only – we are making a good run – similar to the post Bear Stearns failure rally in March. However – I think we can see some volatility. A visit to 1900 or 1950 is a good bet this week. If we do get overextended to the upside and make a run for the 2000 area – watch the short-interest to see if it collapses – that will spell when the run is out of steam.)

SPX 1275 / 1300 (The traders have been wanting to see a big push through 1300 – which hasn’t happened yet – I have a feeling we will touch it – the real question is will it break through. I think these points are get flat straddle points – don’t take long or short hard delta positions without a good hedge.)

RUT 720 / 740 (Well – this has clearly shown on Friday a big flood on money “confidence” coming back into the broader market. 740 is in the cards! I would tend to be a soft short delta (hedged) between the 740-750 area and flat deltas back at 720. I think more volatility is on the way for September and November – not less.)

Interesting that Oil has come off almost 20%, but the market has barely gotten off the bottom (mainly INDU and SPX). I think we need more than oil to come off – but need the domestic economic scene as a whole to get healthier before we see longer-term and stronger rallies. I would not call this a Bull Market yet – but rather a good reprieve from the lows – with more volatility to come. I would also not call this a Bear Market. This market is one thing only – Volatile!

I already got a couple of emails saying “Hey – how come the market rallied – I thought you said it is going down?” – I think these people are reading too much into the support / resistance levels. We are in a volatile market – not a bull or bear market. The support / resistance are ranges to take OFF long and short positions. Remember – I am not an INVESTOR or LONG-TERM trader. Don’t ask me about the market in one year – I have NO IDEA. For me it is about the present!

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Conclusion

The dollar covering rally was a shocker – that kind of move has not been seen in years. The news about SemGroup – which seems to be under-wraps (note CNBC hasn’t really said anything about it – and the CFTC is not making an issue out of it) – but the firm losses over $3 billion in the trade (second largest loss ever in commodities) and is filed bankruptcy. There is probably a lot more to this story – one thing no one can deny – when you need to cover over 100,000 future contracts in oil – you are going to drive the price up big time.

We saw a pretty amazing rally – which really seem to be rooted in the dollar drop coupled with oil. I have a feeling that he dollar short-covering might bring a SemGroup story to light as well. These firms across the board are massively short oil, the dollar, gold, silver, etc. If they get squeezed on capital or P&L – a short covering in any of these issues could send a spike up. The problem? Well – a massive spike in prices because of a massive position being forced to cover muddies the waters as to determining valuation and the economic landscape. If one were to believe that the rally from the 120s to the 140s was instigated by the SemGroup short-covering, how are we to the real economic value. Short-covering rallies do introduce huge volatility in the market and the number of shorts in commodities and the dollar has been growing to epic proportions. Think about this – to have one firm short that many oil contracts is something a few years ago was just unheard off. In Gold and Silver – some of these short positions exceed 100s of days of mine extractions. The dollar shorts had/have reached a massive scale as well.

The only thing this means – is MORE volatility.

Right now we are still at the lows even with a couple of good up days. I think we could get some follow-through – but not because of fundamentals changing in the economic landscape. These are GREAT times to roll-up hedges and lock in gains. Just because we had a rally does NOT mean you should not hedge those hard deltas. It is a perfect time to lock in gains.