Oil's Short Covering Rally

October 28, 2015, 13:17 pm ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

Oil's short covering rally

On Wednesday, ahead of the FOMC meeting, WTI and Crude oil prices in general staged a sizeable rally.  The tracking ETFs, iPath S&P GSCI Crude Oil Total Return (NYSEARCA:OIL), United States Oil Fund LP (ETF) (NYSEARCA:USO), and ProShares Ultra DJ-UBS Crude Oil (NYSEARCA:UCO), were each up big, with UCO posting the largest intraday gain.  This rally was aggressive, swift, and concerning to short sellers in the Oil Space, but 'black gold' has been ruled by short sellers recently, and they are exactly why the commodity fell in the first place.

Ever since UCO hit resistance at $27, which coincided with $50 per barrel, selling pressure mounted.  Supply concerns and inaction by OPEC fueled the momentum declines, and they were serious to anyone long in the space, but when short sellers are as active as they are in Oil reversals like what happened on Wednesday are common.

By definition, short sellers are fast money, and when it comes to Oil they have had a field day, but everyone who trades in the space also knows that these are unsustainable prices.  If this were a stock and not a commodity arguments could be made that the 'stock is going to $0,' or something like that, but not only is that NOT going to happen with Oil prices, but most traders in the space also realize that Oil is not going to stay down this much because its costs more to produce than this, and the economies don't add up as a result. 

Therefore, when turning points come the short sellers that piled in together also cover their positions in unison, and that causes large face value increases like what happened on Wednesday.

Were there associated negative news events over the past week or so that caused short sellers to pile in, of course there were (inventories), and was there a 'not negative' event on Wednesday that prompted short covering, of course there was (build was less than expected), but that's not the point of this article.

The point is that the short sellers in Oil are not like short sellers in stocks whose businesses are deteriorating; as much as they love to pile on, short sellers in Oil are easily to entice to the other side because they ultimately know that the price of Oil cannot and will not stay down for very long.   

In fact, on the heels of the first notion that Oil prices may have bottomed not only will short sellers cover aggressively, but buyers will come out of the woodwork, because almost everyone knows Oil prices need to increase in order to match production costs even in OPEC countries.

Example: If Russia and OPEC decided to cut production in unison WTI and Brent would fly!  In my opinion that day, or a day like that, is coming.

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