Dear Trader,

Martingaling is a gambling strategy.

A terrible one.

One of the simplest, but stupidest imaginable.

The idea is you double your bet after every loss, hoping you eventually win and make it all back. It goes like this: Bet $1, lose. Next bet is $2. Lose that? Bet $4, then eight, then 16, 32, 64, 128.

Uh oh.

It only ends when you run out of money.

And people who martingale always run out of money before the casino or the stock market.

Always.

Even to central banks as powerful as Japan’s.

You see, Japan has a problem: Oil is rising and the yen is falling. Every dollar oil goes up hurts the Japanese economy because it imports 95 percent of its energy through the Strait of Hormuz. As the yen falls, it becomes more expensive for them to buy already more expensive oil that is priced in dollars. Japan is getting crushed by this war.

So what great idea did Tokyo come up with?

Short oil futures.

I read a Reuters article, and then reread it to make sure I wasn't hallucinating.

Japan is floating the idea of using its $1.4 trillion in foreign exchange reserves to build short positions in the crude oil futures market. Their goal is to push oil prices down, which would reduce dollar demand for energy imports, which would also take pressure off the yen.

It sounds clever for about six seconds. Then it falls apart. And this is coming from me, who is (unhappily) long put spreads in the United States Oil Fund (USO).

Here's the logic. Finance Minister Katayama blamed speculative moves in crude oil futures for distorting the currency market. He thinks speculators are driving oil higher than it should be. If Japan can short oil futures and push prices down, lower oil means less demand for dollars to pay for imports, which means less selling pressure on the yen. Yen stabilizes.

That logic works if the rally is speculative. Three weeks ago, it was. In the first days after Hormuz closed, the rally was pure fear premium baked into crude. Traders were front-running a worst-case scenario. I even argued for a short in USO at the time.

But that was four weeks ago. The strait wasn't supposed to shut this long.

Japan Is Already Short Oil

Here's what nobody in that Reuters article mentioned: Japan is already short oil.

Massively.

Synthetically and structurally. They are the most oil-short nation of the major economies.

But wait. They already added another short last week. Japan committed to release 80 million barrels from its strategic petroleum reserves. That's real oil leaving real storage facilities. They've got to buy that back eventually.

That's the definition of getting short. Japan consumes about 3.1million barrels per day. That short buys them roughly 24 days of time.

Now they want to add a paper short on top of that?

So that would be a fourth layer of being short oil.

This is the trader who got stopped out buying the dip. He's furious. "The market should go higher." Instead of stepping back, he says "I just need a bigger limit. Buy more." Same thesis. Bigger size. While the fundamental that stopped him out is not resolving.

There's a name for this in trading. It's called a martingale. It is the only strategy in gambling that has "blow up" mathematically baked in. Japan's bankroll is huge. But it's not infinite. And every layer of this short is correlated to the same variable: does the Strait of Hormuz reopen?

If it does, they win on every layer. They got out of jail. If it doesn't, they lose on all four simultaneously. That's not risk management. That's concentration risk compounding with leverage on top.

Paper Doesn't Fix a Physical Problem

Physical barrels of oil traded as high as $175 in some spot markets last week. Right now the physical is about 20 percent higher than the futures. The difference between paper contracts and physical oil is already blown out because there's a real supply deficit underneath.

If Japan shorts futures, it just makes this gap wider. The physical price doesn't move. Importers, including Japan, pay the physical price, not the futures price.

You can manipulate the paper market all day. But a company chartering a tanker doesn't check the NYMEX close. It checks what the cargo is worth at the port.

And to fund this short, they'd likely sell US Treasuries from reserves, which pushes rates up, strengthens the dollar, and weakens the yen. The act of funding the trade works against the problem they are trying to solve.

Japan knows this. They're trying to buy time until the Middle East situation improves. Fine. Call it buying time. But hope is not a strategy.

A Naval Destroyer Costs $2.5 Billion

Here's an idea.

An Arleigh Burke class destroyer, the US Navy's workhorse surface combatant, costs about $2.5 billion per hull.

Instead of spending $10 to $20 billion on an oil futures market intervention that their own analysts admit would be temporary, Japan spent $10 billion on FX intervention in 2024, for the same amount Japan could contribute a handful of fully equipped naval ships to a multilateral force that reopens the Strait.

Oil doesn't drop a few dollars on a paper short that distorts the problem. Oil drops $30 to $40 because actual barrels start flowing again.

Every problem solves itself simultaneously. Not because someone manipulated a futures curve. Because someone fixed the actual problem.

No one driving a tanker is going to care that Japan shorted crude on the NYMEX. But they will absolutely care if a Japanese warship shows up to escort them through the Strait.

Not numbers on a screen. Steel in the water.

I'm not a military strategist. I'm a trader. And one thing I know is that you can't short your way out of a problem that you're already short.

Tim