Crude Prices Headed North (OIH)(USO)(OIL)

Crude oil futures rose to their highest point in seven weeks this morning, trading above $79/barrel. Cold, snowy weather in the Northeast and the Midwest are the likely suspects for the increase because traders have always taken weather into account in their transactions. The markets are watching the crude related ETFs: the Oil Services HOLDRs (NYSE: OIH), the United States Oil (NYSE: USO) ETF and the iPath S&P GSCI Crude Oil Total Return Index ETN (NYSE: OIL) as the key oil and oil service ETFs.

That whole line of thinking just seems so yesterday. Crude oil stocks in the US are still above the top of the five-year range. US consumers have reduced their consumption, the economy is still very weak, and crude oil imports are lower. None of these points to a solid reason for crude prices to do anything but fall.

Even if the US were to have the coldest winter in years, the overall effect on the crude market should still be no better than a wash, given the factors that ought to depress prices. The wild card in this calculation remains the strength of the dollar.

As the dollar weakens, traders buy contracts in foreign currencies to take advantage of their strength against the dollar. And crude oil also acts as a hedge against inflation, another factor that traders and other investors consider.

What does today’s move in crude prices portend for prices in the coming year? The answer to that depends mostly on how well one expects the global economy to perform in 2010. If you are an optimist, the past nine months’ rise in equity prices reflects just the beginning of a stronger recovery in the first half of next year.

If you’re a pessimist, the global economy, with the exception of China and a few other developing countries, promises to be no more than flat in the first half of next year than declining in the second half. That is not a rosy picture.

In the US, the nearly $800 billion economic stimulus package had its greatest effects on GDP in the third quarter of 2009, and those effects will diminish going forward until they turn negative in the second half of the year. Interest rates, particularly for home mortgages, are rising even though the Federal Reserve is keeping the funds rate near zero.

In the real world, where most of us live, things will continue to be tough. In the world of financial markets, a lot of (weak) dollars will be chasing higher returns. The fundamentals of the market for crude are unlikely to curb that enthusiasm, and a crude price near $90/barrel by July is not out of the question.

Paul Ausick