Leveraged Oil ETF UCO: $20 Price Target Hit; Time To Set A New Target

David Dierking

Back at the end of April, I set a $20 price target on the ProShares Ultra Bloomberg Crude Oil ETF (UCO). At the time, it was trading at less than $13 a share following a 1:25 reverse split that saved the fund from closing altogether.

Calling for a 50% gain wasn't necessarily popular after the oil market bottomed out, but there were indications that states were getting ready to reopen and I felt that could help ignite demand again. A general consensus that oil production needed to be cut contributed to the bullish case.

I didn't think it would hit that target in less than a month, but it did.

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I also said in the original research note:

"This will undoubtedly be a slow road. I'm not calling for the return of $40 oil or anything like that, but I think a return to $25 isn't all that unreasonable."

I felt $25 oil was a reasonable target given it would take into a more balanced supply/demand situation combined with some modestly increased demand. At the time, I didn't believe that $30 oil was in the cards, but the July contract is already back to $32.

CLN20_Barchart_Interactive_Chart_05_19_2020

Where the price of oil heads here is mostly based on demand (although oversupply will certainly play a factor). With the economy slowly reopening in many places across the country, there are early indications that fuel demand is picking up again.

From Barchart:

Fuel demand in the U.S. is improving after data from the California Fuels and Convenience Alliance showed that California gasoline demand rose to 30% of pre-lockdown demand in cities and 50% of previous demand in rural and suburban areas. Also, data from the Florida Petroleum Marketers Association showed that Florida gasoline demand, which had been down as much as 50% in cities, is now down about 20%.

And, of course, fuel demand will be linked to the spread of the coronavirus. If it looks like the virus is being contained and the economy continues to resume normal activities, there's support for higher prices. If reopening results in a second wave of new cases, people are likely to start staying at home again.

Screen Shot 2020-05-20 at 7.42.04 AM

Right now, the trend of new cases in the U.S. is heading down, but we don't yet have enough data to conclusively show what reopening has done to new cases.

Another factor is how countries handle a resumption of previous economic activity. Places like Saudi Arabia have agreed to cut production in light of the current glut, but that tends to change quickly. If prices begin rising and the supply/demand imbalance starts to work itself out, you can bet that there will be an incentive to ramp up production again. If that happens, there's downward pressure on oil prices again.

At this point, I'm inclined to believe there's only modest short-term upside here. WTI crude prices were in the $50s pre-coronavirus and there's a tendency to believe that they will return to that level once it looks like the economy will return to normal.

Optimism is high right now, but I'm not sure it's fully justified. The market is pricing in a lot of good news and very little potential for things to turn negative again.

In the short-term, I can see current momentum carrying UCO from its current level of $21 to around $24. It's only modest upside, but it's reflective of the current rally beginning to gas out.

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Conversely, I think there's some above average downside risk here. I'm not necessarily forecasting it, but a return to oil in the low $20s could carry UCO back down to its original May baseline of around $16.

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Overall, I believe the risk/reward for oil has changed from bullish to neutral. It's been a fruitless effort to bet against investor optimism and Fed support. I suspect that will carry oil prices modestly higher from here, but there's increased potential for a downside shock.

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Comments (9)
No. 1-4
Themat
Themat

Is it possible for UCO to return to pre pandemic levels (for example $300 to $400)?

Junior01
Junior01

David: thank you for all your helpful insight on UCO and USO - they have been my best performers since late April. Adjusting for the reverse split, UCO was in the $300-$500 range in January and February and now is clearly at a fraction of that even though oil is back up significantly. Under the new “rebranded” UCO, can you see UCO making it back to those levels once we get through this pandemic (2+ years)? Or does their revised risk/return model make that unlikely? It is ok to take a long view on UCO? Thanks!

Brandon B
Brandon B

Hi David! Thank you for the insight. So with a 60% profit based on this climb, would you continue to hold on or sell to make your initial investment back with reinvesting profits? What are the risks for both? What would it take to lose total investment? New to futures and I received an email discussing the potential risk of total loss due to buyers/sellers. This is the article I received regarding the risk: https://www.prospectusdocs.com/eol/request?PAGE=DISPLAYPAGE&cid=964815&DocType=1&s=74347Y888&control=000450015250&type=P

rona2020
rona2020

@David Dierking Looks like UCO will hit $24 any day with the U.S. gradually reopening up and demand increasing. When do you anticipate over supply in the market to impact oil prices/UCO price? Isn’t the market over supplied at the moment with barrels being held offshore and stored in tankers?


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