Oil Skyrockets and Wall Street Panics -- Here's What to Do

As you read these words, your humble editor will be somewhere over the Atlantic (on an Air France flight to LAX). Normally I don't mind being out of touch with markets on a short-term basis. The type of trading I do, and the type of trading we here at Taipan focus on, doesn't require being glued to a screen.

I sure wish I had my screens right now, though... and you better believe I'm going to fire up my twin 24-inch flat panels the second I get home. Because this could be a big day and a big week.

Oil went nuts on Friday (as you may well know), and the Dow and S&P went into crash mode as a result. It's easiest to let the charts speak for themselves, so here they are.

To get a sense of the carnage this caused (or strongly contributed to, rather), take a look at Friday's action in the S&P 500 in the following chart below. Not pretty.

Notice the size of Friday's downdraft (i.e., the height of the big red bar). Bigger bars mean volatility is expanding, which, in general, means fear and uncertainty are rising. The Dow chart is just as ugly as this one. The Nasdaq, in contrast, was spared somewhat, because tech isn't as exposed to oil as so many other industries.

Getting back to crude oil's rocket ride, there are a few key factors as to why the jump happened. We'll touch on those in a moment. But first, try the following factoid on for size: Oil's $11 per barrel jump on Friday, a single-day record, exceeded the purchase price for an entire barrel of oil back in 1998.

To put it another way, a decade ago oil was trading around 10 bucks a barrel. Fast-forward to 2008, and $10 is one little trading day. Yowza!

Plenty of reasons were cited for the big surge. Some pointed to a newly sliding dollar and increased chances the greenback would go down in flames. (The dollar's woes, in turn, were the result of fresh recession fears and unemployment at a multidecade high.) Others pointed to Iran, the rising drumbeat of war, the stubbornness of OPEC and more $150 per barrel talk. Odds of a U.S. military attack on Iran -- or an Israel-led air strike on Iran -- are rising again.

At the same time, it's becoming ever more apparent that "resource nationalism" is changing the game. The wild card of government resource ownership (i.e., the world's oil in the hands of countries like Iran, Russia, Venezuela, Mexico, etc.) is further degrading the quasi-free market system. The countries with massive amounts of oil in reserve have less incentive to pump more oil when the price rises. Instead, they can just sit back and enjoy the increased revenues.

These countries are also very bad at keeping up with cutting-edge technology, infrastructure and manpower. Just imagine if, say, the U.S. Postal Service were in charge of Exxon's reserves. That's about where we are in many of these countries. The supply-and-demand relationship is broken down.

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The Pollyannas get Pummeled

For the longest time, there has been a group of die-hard naysayers waiting for the price of oil to collapse. These Pollyannas have stuck their fingers in their ears and chanted "nah nah nah" for months -- or make that years -- as the price of oil has climbed. They have clung to the assertion that high-priced oil is nothing but a bubble.

With oil roaring higher and higher still, the Pollyannas are now getting pummeled. The evidence no longer gently contradicts them. It bellows at them like an airhorn. (Perhaps an 18-wheeler horn, given the state of the trucking industry and the news that gas is now officially $4 a gallon nationwide.) It's not just speculators and traders. It's not just a temporary blip. The elephant in the room not only won't go away, it's starting to get upset.

For the past few months, Wall Street pundits have been of two minds. On one side, you've heard the crowd that says, "sell commodities and buy financials." These are the folks who repeatedly said, "Oh don't worry, oil is going back down any day now. This is all just a tempest in a teacup." They are also the folks who said, "Oh yeah, you should buy the financials down here. Lots of attractive values. The banks are safe now, the worst is over. Forget oil, forget about commodities."

If you've been reading Taipan Daily for a while, you know we're on the other side of the table. We've been ruthless in skewering the Pollyannas... and in pointing out that commodities are still solid and the financials are still crap. (Not a big fan of that word, but if ever there was appropriate use for it...)

We've pounded the table for shorting the financials, in fact, while regularly pointing out attractive entry points. We've also pounded the table for gold, which is back above $900 and preparing for lift-off again soon.

Get Shorty

So what to do now? Where to go from here? That depends to some degree on where you've been.

The first question to ask is, do you have any strong short positions on? Are you comfortable with the act of shorting stocks and ETFs, either directly or with limited risk options trades? And if not, why not?

Check out the above chart of the Philly Bank Index. This chart, and a number of other financial charts like it, encapsulates the pain of the financial.

See that nice downward move from early May? That represents countless billions in long-side losses ? and major potential profits for those who had the foresight and the chutzpah to go short.

Chart hindsight is 20/20, of course -- but we're not talking about hindsight here. Taipan Daily has been on this trend early and late. In fact, on May 9 we specifically said, "This is a nice short setup (referring to the XLF financials ETF). There will be some bearish trigger-pulling here soon." And there was... and it was nice setup indeed.

The point of telling you this isn't to brag about market calls. It's to help you make money and avoid losing money. The Wall Street pundits who sang "don't worry, be happy" as the markets burned have cost investors hundreds of billions. They pulled the wool over the eyes of all who believed them, and pulled it over their own eyes, too.

Ad yet, while the Pollyannas have been doing CNBC rounds of Kumbayah, we at Taipan have been saying, over and over again, that this is not a time to be complacent. This is a time to be going short.

Taking a Knife to a Gunfight

So learn how to go short, or at least consider it. That's the first big piece of "what to do" when Wall Street panics and markets get wild like this.

It used to be that investors could get by just fine without sparing a thought for the "dark side" of the game. With the late great bull market that lasted from 1982 to 2000 or so, shorting just wasn't all that necessary. But now, with markets the way they are, not being able to short is like taking a knife to a gun fight (in my humble opinion).

Some will object that shorting is a scary proposition... that it takes more guts and a stronger stomach lining than many investors have. To which my response is, "Well, yeah. But have you seen these markets lately? What's the alternative? Do you really and truly want to grow your long-term assets in all manner of market conditions, or would you rather hand them off to some mutual fund manager and watch your nest egg disappear?"

Shorting will never be for everyone. But if you think it might be for you, Taipan help you learn about (and profit from) this dark art.

Adam Lass of WaveStrength Options Weekly, for example, has made a killing on the short side for his readers, and done so safely with limited-risk options trades. In fact, speaking of battered and bloodied financials, Adam has been pounding the table for shorting the banks harder than anyone I know. (Go back and look at that Philly Bank chart again.)

Elsewhere, Ann Sosnowski of Death Cross Trader has also been making coin for her readers on the short side -- again with limited-risk options positions, where exposure is fully controlled.

In a market environment like this, you don't want to panic. You want to be prepared, and you want to be versatile. That means having the option (no pun intended) to go short.

Know What to Buy, Too

Another key aspect of "what to do" in markets like this is knowing what to buy. Just because the major indexes are dropping like a rock doesn't mean that everything is dropping. Some stocks and commodities and currencies continue to go up and up.

Take a recent "cleantech" recommendation from Sally Limantour of the Taipan flagship newsletter, for example. You can get the details of that story here. Sally's pick -- a long-term investment pick, mind you -- has almost doubled in a matter of weeks.

On a day when the Dow was down 400, this stock closed 97 cents from a new multiyear high. And there's probably a lot more where that came from. (Follow the link above to read why.) Oil in the stratosphere is bad news for most of America, but for some companies, and companies in the cleantech space in particular, it's very good news indeed.

It's important to know who wins and who loses as a result of large market moves. The answers aren't always as cut and dried as you might think. Not all oil stocks benefit from $140 oil, for example, as Andrew Mickey points out in today's Chart of the Day. Certain areas of the oil industry do incredibly well, with reason only to cheer as oil powers higher. Other energy-related companies get white-knuckled as the cost of their raw input (crude oil) threatens to grind profit margins into dust.

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Survival in a Nutshell

Really, the survival guide to markets like this can be reduced to four elements:

Don't panic.
Learn how to short.
Have conviction.
Know what to buy.

It may sound simplistic, but there's a lot of power packed into those four little bullets.

If you refuse to panic, you'll be able to keep a clear head and avoid any major bone-headed moves when others are running around like chickens with their heads cut off.

If you learn how to go short -- and better yet, use short positions to help balance out your long portfolio -- you won't wake up in a cold sweat when the Dow drops 400 points and the markets are drenched in red. (You might even start getting a kick out of big down days, as some traders admittedly do.)

If you develop firm convictions, you'll be less swayed by the pundits and the talking heads on CNBC whose advice constantly wavers in the wind (and is worse than useless most of the time).

And finally, if you know what to buy -- in terms of using your conviction to understand what's happening and separating the winners from the losers -- then you shouldn't have any problem navigating even the wildest market waters.

Warm Regards,

JL

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