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Vale SA (ADR) (VALE), United States Oil Fund LP (ETF) (USO) – Commodities: Long/Short

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With ten-year Treasury rates spiking fast and stock prices moving down, it’s remarkable to see how resilient commodity prices have been during the past few weeks. Here I make a supply and demand analysis of three popular commodities. Whether you have them in your portfolio or not, you may want to take a look at what has been happening in this markets. Here I will also offer some ideas to play those demand/supply dynamics.
Crude oil: Stability on the horizon
The outlook: Oil prices remain remarkably resilient given the bearish consensus and a highly uncertain world. As a matter of fact, I do not see a strong enough shift in the fundamentals to knock prices out of their their quarterly average range. Nevertheless, rising risks to emerging market economies (China and Brazil are growing at slower rates), which are the engines driving oil demand growth, mean that oil consumption shouldn’t rise by more than 1% in the second half of the year. That said, price support keeps coming from the supply side. Production outside the US is still underperforming, while flows from sovereign producers remain well below expectations.
The suggested trade: When prices remain flat the correct strategy is selling out of the money call options. Hence, I would suggest selling October 2013 United States Oil Fund LP (ETF) (NYSEMKT:USO) call options. Since the ETF that reflects the price movements of light-sweet crude oil trades at around $33 (1x NAV), I would sell calls with a strike of $35 since they offer a great 3.5% premium (+$1.10 per contract).
North American gas: rising expectations
Not only do I expect the US natural gas supply to remain abundant, I also expect production of US dry-gas to keep on growing. Nevertheless, I think price momentum is building, essentially since an unusually long winter created a deep inventory deficit compared to the 5-year norms.
I would expect second half 2013 prices to average $4.20 per million thermal units (MMBtu) against today’s $3.67 per MMBtu. This 14% upside potential could be realized on the basis that lower storage levels will require higher gas prices relative to coal to adequately loosen the summer supply/demand balances.
That said, I would also expect prices to go down to $4 per MMBtu in 2014, as supply grows thanks to new processing plants. Besides, the second wave of the Marcellus pipeline at the end of 2013 should also put some pressure on prices.

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