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Crude Prices Plunge - UltraShort ETF Positioned for Profits

by: Andrew Snyder October 15, 2008 | about stocks: DUG / OIH / OIL / USO / XLE    

Andrew Snyder

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Somebody better call up General Motors (NYSE:GM) and warn it about its huge mistake. The company, which is so huge that it takes a decade to react to an evolving market, is about to significantly cut the production of its full-size lineup.

It does not realize these are going to be some of the best selling cars in the next few years. Make more Hummers, not Volts. The company is making a huge mistake.

Last weekend, I saw something I have been waiting to see for a long time. Gasoline was selling at the corner station for just $2.99. Three years ago, I would have screamed with prices that high. Now, I am celebrating. More importantly, I am dusting off my Hummer. Those prices are going down even further.

So long Saudi Arabian riches

Thanks to fears of a strong global recession and larger-than-expected downturns in pivotal countries like China and India, crude prices are on the decline. Right now, a barrel of oil is selling for nearly half of what it did during its record-smashing peak just a few months ago.

But we have not seen anything yet. Crude prices will continue to fall. And if you invest accordingly, you can put some hefty profits in your pocket.

Earlier today, OPEC announced it has significantly reduced its oil-demand forecast. The group says it now believes the world will require 87.2 million barrels of oil each day next year, a decline of 450,000 barrels. It also announced its members will most likely cut production by one million barrels per day.

Today’s news solidifies the belief that oil supply has finally overcome global demand and a surplus is on the way. Crude prices will continue to fall.

As an investor, you have many ways to play this situation. You can invest in the companies that will do well when oil prices fall. But in a recessionary economy, that is a risky move.

A better bet would be to short oil producing companies. You can directly short companies like Exxon Mobil (NYSE:XOM) or you can purchase put options.

But what if you want to directly short oil prices? After all, shorting an oil-producing company is far from a pure play.

The best way to take advantage of falling crude prices is through the UltraShort Oil and Gas ProShares (AMEX:DUG). The exchange-traded fund (ETF) moves inversely to the daily fluctuations of oil prices at a two-to-one ratio. In everyday words, if oil prices go down two percent, the fund increases in value by four percent.

It is a pretty sweet deal when crude prices are dropping, huh?

The country is in the grips of a recession and the equity market is all over the place making buy-and-hold investors nauseous. I know it is tempting to keep your money on the sidelines, but it can be a costly mistake. There are gains to be made out there.

Invest in the UltraShort ETF and take advantage of crude’s decline. We made money as prices soared. Now we can make even more as they plunge.

Disclosure: none

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This article has 11 comments:

  •  
    Oct 15 12:11 PM
    Opec will simply cut its quotas to ensure that price remain at this level (or higher).

    In the long run we are in a era of peak oil which means oil prices will go sharply higher.

    While someone who is a trader may be able be able to move in and out of oil at the correct times--this is comparable to someone who predicted the massive decline in stock prices in the last month of so, the high one-day run-up and following decline.
    Reply
  •  
    Oct 15 12:27 PM
    This strikes me as a less-than-thoughtful analysis. Clearly the momentum at present favors continued declines in oil prices, but what happens when the impacts of the global inflation regime created by the trillions of dollars in newly-issued central bank scrip begin to be felt? What would be the impact of oil being priced in a currency other than the dollar (though what that would be now seems a challenging question to answer).

    It seems imperative also to consider global instability and "wild-card" factors in making these decisions, too. What happens to the price of oil if Israel attacks Iran and Iran blocks the straits of Hormuz?

    The article isn't investment advice, it's a gambling tip. You may have the best of it for the next hand or two and maybe the DUG is a good gamble if all current trends hold and if no wild-card scenarios arise.
    Reply
  •  
    Oct 15 12:30 PM
    I have had DUG since $135 oil on the way up, a wild ride. Doesn't necessarily correlate to movement in oil, more with oil and Nat gas equities. Sometime fluctuates with no rhyme or reason. Down 40% on the 1100 point rally Monday, up today. Played out, late in the game, OPEC action in Nov?, it may need to be sold soon. Used as spec play, recession hedge. Rest of portfolio getting killed, Wilder, options on DUG and DIG if available.

    disclosure: own DUG, may sell as soon as today. Do not follow my advice or thoughts, I am clueless what to do.
    Reply
  •  
    Oct 15 12:44 PM
    Once again, a Seeking Alpha blogger gets DUG's investment objective and profile wrong. DUG is intended to return twice the inverse of the daily performance of the Dow Jones U.S. Oil and Gas Index (^DJUSEN), NOT twice the inverse of crude oil price movements. DUG and ^DJUSEN's performance charts are near-mirror images of each other, so it does hold to its objective quite well. ^DJUSEN's components (roughly 100 oil and gas exploration, production, equipment, services, etc. companies) can be found here:

    www.djindexes.com/mdsi...

    While DUG and crude do move in relative tandem, a better pure contrarian bet on the price of crude (the article's crux, after all) would be through DTO, the PowerShares DB Crude Oil Double Short ETN, which, per its stated objective, attempts to return twice the inverse of an index constructed to reflect the price of crude oil.

    For the sake of your readers, Mr. Snyder, in the future please do at least a modicum of basic research on the investment vehicles you recommend before publishing your views. It will serve you, and us, better.

    Regards,

    Matt
    Reply
  •  
    Oct 15 12:51 PM
    Even if your analysis is correct (I have my doubts) I hope you are kidding about "dusting off" your Hummer. Regardless of the price of oil, we need to wean ourselves from reliance on petroleum and its derivatives.

    Dependence on oil is the fly in the ointment for America's foreign policy, our global leadership and respect, and the sustainability and viability of the environment. As long as we are dependent on oil (and particularly foreign oil) America will never be the respected global leader and economic power that it used to be.
    Reply
  •  
    Oct 15 12:58 PM
    From your BIO "sharp, deep-thinking analysis."

    You're a joke. I was bearish on oil at $130 on the way up. You're bearish now? Are you serious? Is this a Cramer spoof?
    Reply
  •  
    Oct 15 01:53 PM
    Good luck with that Hummer, buddy. Demand may have fallen, but oil is thus far an inelastic good. People still drive to work and OPEC is cutting production to maintain economic and political power.
    Reply
  •  
    Oct 15 02:16 PM
    Matty is correct.

    Today (Oct. 15) NYMEX crude is down < 5% whilst DUG is up ~25%

    This is nowhere near the numbers the author states.

    A wild ride indeed! But approaching a $60 to $70 trading range to trade DIG/DUG in.
    Reply
  •  
    Oct 15 05:25 PM
    Some thoughts:

    nearing $70 a barrel supply destruction will begin to kick in (e.g. OPEC will curb production).

    oil shorts are way in the money and likely to take some profits

    Demand in emerging markets (less susceptible to current crisis) will continue to rise

    Winter is imminent in the Western Hemisphere

    Peak Oil?

    We shall see...
    Reply
  •  
    Oct 15 05:51 PM
    This guy is why we are in the mess we are in - "dust of my hummer"...give me a break...the current price drop in gas is related to oil...but is also a political reality - oil mergers in late 2003 early 2005 saw gas prices doubling by early 2006 - before the price of oil got going...gas prices fell about $1 between August 2006 and election day...hmmm.... good try Bush/GOP.

    Yes, we will see a sustain pricing stratum of @$65 (actual cost to produce and sell) - to $88...the price that includes speculative/geo-pol/do... valuation profits and the price the Saudis want) for the next 24 months...but, soon it will work its way back to over $100, and with no position limits, another bubble rally will get going as world supply and demand start to find equilibirum at 88mbpd in mid 2010....
    We should take advantgae of this reprieve and go green, or we will find ourselves in $150 in late 2011 / early 2012 and back into another global recession...
    Reply
  •  
    Oct 16 11:46 AM
    YogiG is on course with those predictions however the oil producing countries have seen their investments go down and will not obide by their quotas in the near term. They simply want that cash flow to continue. Thanks Matty for setting the record straight
    Reply
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