Don't be Fooled - Oil Will Drop Again

The two-day rally we've been seeing looks suspiciously like a Wall Street Rope-A-Dope.  Someone cashed in a $600M position in DWTI (3X Inverse ETN for Oil).  Essentially, this Exchange Traded Note uses Put options to short the market and profit by more than the proportional moves in the actual securities it's trading.  This is one of those sources of the "Wag the Dog" effect we are seeing in our markets today, and is a huge source of volatility as the leverage is extreme.

An article from Reuters cites this transaction as a reason for the apparent counter-intuitive rally in oil Wednesday and Thursday.  The fact of the matter is that supply is up roughly eight million barrels, and this will affect prices negatively.   While the Dow Jones partied today, the DWTI partied as well, and that's not good for the bulls tomorrow.

If we look at the SDOW (3X Inverse ETF tracking the DJIA) we see the pullback based on the rally in the Dow.  Today, that pullback slowed a little.

Now look at the DWTI.  Sure, it pulled back on Wednesday, and the short covering I'm sure had a lot to do with sparking the rally but today's accumulation is going to show up in tomorrow's performance.  There will be a lot more short positions in oil tomorrow and this will stunt the rally.

The thing that bothers me, and I even took a defensive stance in my own 401k over it, is this:

The tops in the Dow's chart are not making a bullish long term pattern, but the lows and the averages are telling me that this is likely to be a protracted trend rather than the sharp but quick painful ripping off of a band-aid.  This is more of a sprained ankle or worse.  The biggest problem is that we have people talking about "buying opportunities" just a day or two after cautioning people to, "sell the rallies."  I do hope my readers a PAPER TRADING right now because this is going to get ugly.

Reasons?

1) European banks are under funded (liquidity is seriously low).

2) Collateralized debt has valuations that may be suspect (A spike in BK filings may reveal far lower asset values than we're assuming in Oil as well as other sectors like Commercial Retail who seem to think they'll spin off their properties into REITs.  Really?

3) A lot of cash left the market over the last year and it seems to be appearing in ETFs.

4) ETFs loaded full of High Yield Bonds will have great troubles if the banks in Europe become ground zero of the next Lehman Brothers Event (like the TNT that sets off the plutonium in the Fat Man bomb).

5) I still wonder where all the CDOs went from 2008.  ??

For anyone still hanging on to HOPE in this rally, I'll leave you with this image:

This is the Daily plot of the DJIA over the last 100 trading days.  Those last two candles are looking pretty hopeful, but I'm not putting money on it - not even a paper-trade.

Disclaimer: This blog is for informational purposes only.  I may or may not have positions, long or short, in any stock or security mentioned anywhere on this site or elsewhere at any time.  It is the sole responsibility of the reader to interpret the contents here, and to seek the advice of a qualified financial professional before engaging in any trade.