Oil spikes above $40 due to short-covering; bearish case remains intact

Oil surged more than 7% Thursday and briefly traded above $40, after U.S. weekly oil inventories unexpectedly declined. But traders don't view it as a market reversal.

The oil bulls are certainly trying to make the case that oil has bottomed at $35. Officially, oil for March delivery closed Thursday at $39.48 per barrel up $4.86 on NYMEX.

You, too, must be an oil bull if you believe the recession is over. And if you believe layoffs will start trending lower. And if you believe household formation will increase. And if you believe business investment will increase at healthy rates. And if you believe the worst of the financial crisis that's constricted credit is behind us.

As the oil bears would quickly point out, however, there's a lot of 'ifs' in that previous paragraph.

That is why bears like energy trader Paul Schmidt have kept their short trades running. "Today's action is largely an overreaction to the inventory number, which fell by 138,000 barrels in a surprise, and due to short-covering." Schmidt adds that he is currently short oil and natural gas.

In other words, it pays to pull the lens back, for context and perspective. There are financial institutions and traders who opened oil-short and comparable positions when oil was at $70, $90, even at $110, Schmidt says. "Any sudden anomaly or a large daily move will cause some of these guys to close positions, and you get a quasi-short squeeze."

Quasi, Schmidt adds, because, technically, it's not a loss-induced short-squeeze, but profit-taking after a long, long walk down for oil.

Which is why, despite the U.S. Energy Information Agency's report of a 138,000-barrel draw in weekly oil inventories (Bloomberg News consensus was for an increase of 3.2 million barrels), Schmidt expects oil to resume its downward path in a day or so.

Mybias remains with the oil bears. What would reverse that view? How about a 2 million barrel per day (or larger) production cut by OPEC at its March meeting in Vienna? A substantial decline in U.S. lay-offs, to under 300,000 per month could also do the trick.

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