Oil prices reached their highest levels in nearly 2.5 years Monday sparked by a potent combination of fear, greed and hope.

An increase in the saber rattling between the Saudis and Iran, directly or via their proxy factions, is sparking fears that production from 2 of the world’s largest producers may be put at risk.

It seemed like it took a while Monday morning for the market to digest all of the news coming from Saudi Arabia over the weekend, but after a quiet start the momentum clearly shifted back into the bulls favor mid-morning and the rally was on.

Greed is ample as large speculators are holding a record number of positions betting on higher energy prices, and apparently aren’t yet looking to take profits even though prices have rallied by 17% in the past month.

Hope is being provided by equity euphoria as the 3 largest US stock indices reached new record highs, extending one of the longest rallies in history.  If that weren’t enough, Broadcom is offering to buy Qualcomm in what would be the largest tech acquisition in history, and Disney is rumored to be making a play to buy 21st century Fox.  Those types of mega-deals (think AOL/Time Warner) have been hallmarks of contrarians that love to point out how the over-confidence felt by investors when markets top out encourage executives to outkick their coverage financially.

The question for now is if these 3 factors can continue pushing prices higher, or is there a correction looming?  While several analysts have already made calls for $60 WTI and $70 for Brent, there are some signs that physical markets in the US are no longer supportive of the rally in futures, as basis differentials for gasoline and diesel markets began falling in the midst of the rally in NYMEX contracts.  That pattern should be watched closely to see if the fundamentals will continue to support the rally into the winter, or if reality is about to set it.

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