Fundamental Trading Diary

Fundamental analysis of the capital markets

2008 Year In Review

Exxon Mobil vs USO

Figure 1. Exxon Mobil vs USO

Many of the things I predicted — like the oil bust and USD appreciating against the Euro — came to pass, but I’m still waiting for some of my other ideas to really spring into action.

Silver is trading at $11.07 – certainly a higher price than when I recommended it, but the fundamentals support a much larger price move.

Oil & Exxon Mobil

Exxon Mobile is still an $80 stock.  Figure 1 contrasts the price of oil against Exxon Mobile, and plots the ratio between them.  The ratio is surprisingly trendy, and has been nearly vertical for the last six months.  I think this trend is likely to head the other way very soon.  Here’s why:

  • The last time oil & gasoline were at these levels, Exxon Mobil was worth half as much
  • Although they ostensibly have improved infrastructure to improve profitability (which I overall doubt:  it’s becoming more difficult and consequently more expensive to draw oil), inflation will have roughly doubled employee, machinery and their own energy/transport expenses
  • Exxon Mobil has a massive cash reserve that can be used to play accounting games to smooth out earnigns – this likely limits their downside, but this also limits their upside unless oil starts to return closer to the $100 level
  • Monetary inflation
  • New New Deal spending will have a large energy component – tar for the roads, fuel for the trucks and heavy machinery, and that deficit spending will also promote more monetary inflation
  • Geopolitical conditions aren’t likely to improve

As a consequence, my idea is a pair trade.  The position is equally long USO ($33.68) and short XOM ($79.26).  Closing the trade will happen when the contraction in the XOM/USO ratio turn to expansion.  I’m estimating that this will probably be a six month trade (giving it enough time for the monetary inflation and bailouts to gain traction), and a profit of 15-20%.

The January Effect

The January effect is the predisposition for small capitalisation stocks to outperform large capitalisation stocks in January.  According to World Beta, after the 10 worst years on the S&P 500, small-caps have risen an average of 18% the following January.  2008 easily qualifies.  The play here is to buy TNA (Direxion Small Cap Bull 3X Shares @ $35.88) and short BGZ (Direxion Large Cap Bear 3X Shares @ $55.57).  History suggests that this is essentially a risk free trade, and is probably worth 5-10% in January.

More later ..


January 2, 2009 - Posted by | Uncategorized

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