How You Can Profit From The Doha Meeting

In a forex dealing room, where I got my start and my training, talking your book is a time honored tradition. In its simplest form it consists of simply telling everybody you can find that "…this thing looks bid to me" if you are long or, if you are short, that "…the bottom's about to fall out of this". The practice has been around forever, but has limited use as everybody in the market assumes that everybody else is talking their book whenever they offer an opinion. Far more effective in many cases is to start a rumor and watch it take hold.

Traders simply identify another of their kind who cannot keep something to themselves and then tell them about some huge order about to be filled, or that they have heard that the jobs number, GDP data, central bank decision or whatever is going to be sensational in one direction or another, and, of course, to keep that information to themselves. A game of Chinese whispers then usually ensues, with the end product being an anonymous, exaggerated version of the original story. I have no evidence that the rumors that have been swirling around about this weekend's OPEC meeting started like that, but it certainly smells that way.

We have witnessed a run up in WTI from around $35 to around $42 over the last week or so. That 20 percent jump in prices came despite ample evidence that supply is still outstripping demand and the beginnings of a bounce back in the dollar, two fundamental factors that should militate against higher oil. Fundamentals, however, are not what most observers say has driven the action; rather it is an expectation that something good will come out of the OPEC meeting scheduled for this week.

The problem with that analysis, of course, and the reason it looks to be almost entirely rumor driven, is that the most important party in the impending discussions, Saudi Arabia, has repeatedly said that, while a freeze in production is possible even without Iran's participation, an actual cut is not. The first talk of such a freeze came in February and sparked the run up from the lows around $26 to above $40. At that point reality set in and we returned to around $35 before the current push up.

From a trader's perspective, this looks like a classic "buy the rumor, sell the fact" setup. The rumors have certainly been around and the buying has happened. In theory that means that even if there is the potentially good news of an agreed freeze, then the market, with that already more than priced in, could react sharply downwards. Only the unlikely outcome of a production cut would cause further gains. That make shorting oil into the meeting an appealing, if very risky trade.

The risk comes, not so much from the possibility that the OPEC members will emerge from the meeting and announce a cut as it does from the timing. If you short oil, whether through the futures market or a leveraged ETF such as DWTI, you face the possibility of relevant news emerging when the market is closed. That means that stop loss orders cannot realistically be used to protect your position as, in an extremely thin or even non-existent market, filling at the "next available price" could mean anything.

That is why, if you take the trade, it is important to be conservative in terms of position size. You could easily end up stuck on the wrong side, waiting for the market to open which I can assure you, is not a good place to be. That said, though, the likelihood of that worst case scenario unfolding looks minimal based on actual evidence rather than rumor. The worst thing imaginable for the Saudis at this moment is a production cut that leads to a shortage that Iran, their enemy in proxy wars around the peninsula, can fill. Even worse, that increase in Iranian market share would come at a time when prices were climbing. The most likely outcome, then, is some kind of a token freeze or cap. That is unlikely to come with Iran's involvement, and if it does the level of trust needed to make it work is almost impossible.

From a market perspective we still have a glut of oil, we have global growth prospects that have just been reduced again by both the IMF in a general sense and the IEA in estimates more specific to oil, and we have continued production at record levels. At some point not too far away, oil prices will most likely push back towards $50 as U.S. production slows and demand catches up, but the chances of further gains this weekend look slim…If anything this just looks like the ultimate "buy the rumor, sell the fact" trade.