A compelling case for buying oil

January 26, 202114 Comments

While markets continue to display overbought signals, there is still value out there. Today, I’d like to take a look at oil again. Recent developments may be presenting a case to add to oil investments if one has a 1-2 year investment horizon. Bear with me as I move through some broad-market trends that add to my bullish oil and gas outlook.

Markets are pricey, but that pricing is concentrated

Lets look at one reason why markets are becoming so pricey. I don’t have data to correlate with short interest and market movements, but this may be an interesting contrarian signal to explore. Short interest is shrinking. While markets move higher, shorts get squeezed out, creating ever higher prices (short covering adds to buying):

Short Interest as a % of S&P 500 Market Capitalization

2021: 1.3%
2020: 1.8%
2019: 2.1%
2018: 2.8%

BearTraps research points out that despite some single-name stocks with high short interest ripping higher, the number is shrinking. Moreover, there are almost no shorts left against benchmark indices. Meanwhile, over the last 3 months, we’ve seen the highest inflows into equity funds on record. Inflows into US small cap funds have surged enormously lately, with the largest 4-week flows since the inception of EPFR data…perhaps these high beta stocks are becoming an overcrowded trade?

Goldman Sachs expresses similar thoughts as the ValueTrend view, which I blogged on last week  – click here. That is, this market looks like a barbell, with weighting over mega overbought and mega oversold at each end.

GS: “unsustainable excess” in pockets of U.S. equities, “consistent with bubble-like sentiment. But these excesses present low systemic risk to the broader market given their modest share of market cap.

Biden Signs Order Boosting Federal Spending on U.S. Products – Bloomberg:

“President Joe Biden signed an executive order on Monday to boost federal agencies’ purchases of U.S. products, fulfilling a campaign pledge to lay out a “buy American” plan…. Biden’s order also directs a federal panel to finalize changes within six months that would tighten standards defining American-made products to ensure they are manufactured with a higher percentage of U.S. components and labor, officials said.”

Made in America but Parts from China has been the status quo  in recent years. But – If that’s changing, inflation is going up!  US labor vs. Chinese labor cost is estimated as 5x more expensive.  Moreover, Biden is jamming a higher minimum wage and Union power.  Biden is guaranteeing meaningful inflation is coming
Yes, it wont hit us right away. But that doesn’t mean it isn’t coming.

Oil will be one overlooked area that may benefit from inflation

Quote from Bloomberg piece (Niall Ferguson): Link

“The vaccination program, combined with the naturally acquired immunity of people previously infected with the virus, would probably get the U.S. close to herd immunity by the summer, even if Joe Biden spent the next six months just riding his Peloton”

My question is, what happens when people go back outside? They drive more! Traders are beginning to realize this potential- gasoline is rising- here is the Bloomberg chart:

 

Why I like oil: This ain’t rocket surgery!

I just finished writing a chapter in my upcoming book on contrarian investment strategies. In that chapter, I covered the massive selloff of crude oil when futures went negative (!) in price in April 2020. This was brought on by shrinking storage capacity while producers kept the taps wide open. Fears of running out of storage / rising cost of storage drove traders to pay (!) to get rid of their oil contract. After back-office meetings between the Trump administration and Saudi/Russia, taps began to close. Crude oil rebounded over the summer and early fall, only to decline aggressively again (not so severely as to go negative, but still…) in November. This, as the Biden “green” agenda began to look more probable. Market players failed to realize that seismic changes in consumption would not change overnight. Further, usage of fossil fuels in China and India (largest growing economies), amongst other developing nations, were growing, not shrinking- which will vastly offset future green movements –discussed here. Meanwhile, production had been cut….simple equation here folks:

Falling supply, same or rising demand = higher prices.

Canadian energy producers

I’ve noted in the past that energy producers can be a good mid-long termed play on rising oil prices. Canadian producers are being pressured due to Biden’s recent crushing of the XL pipeline deal. But oil is oil, and it seems to me that well chosen producers are presenting a contrarian play. The XEG chart shows a bottom breakout with a recent neckline test after an overbought stochastics and RSI signal. Overhead resistance (target) suggests $8-$10 – not bad!

Soon it will be time to add energy positions.

14 Comments

  • This morning I took a partial position in Suncor. We’ll see how it plays out. On XEG, if you decide to buy it, how long will you hold on? Seasonally oil comes into play in late February I think.

    Reply
    • We own SU as well–not sure if we would buy the XEG or just keep adding to individual stocks. Right now we have 2 gas-heavy producers, 2 oil-heavy producers (SU is one of them) at about 2% in each. There may be some noise in the nearterm. Could pull back further towards that neckline. Buy on dips me-thinks

      Reply
  • I like the timing of Oil here as well, but with fossil fuels becoming a taboo investment with many investors, institutions, and Governments, is Oil and Gas heading toward the same fate as the cigarette companies?

    Reply
  • At $50 oil, don’t the major producers break even and then just continue to ramp up production?

    Reply
    • Good question…I think it all comes to supply/demand. Right now demand is lower. Supply has been curtailed and there will be a lag in that supply (production) when things pick up – especially in light of growing demand in the developing world. They (big producers) will ramp up production for sure, but demand will also ramp up, so the likelihood is both–more production, rising prices. All good for the producers IMO. But, as I said, this may be a 1 year play, not a one month deal.

      Reply
  • Nice article Keith,

    I’ve been holding Whitecap (WCP) now for a couple of years (got into it too early) but with their recent acquisition of Torc Oil (TOG) I have high hopes for this light oil stock (long life reserves, slow decline rates).

    I’ve also recently bought into the Tourmaline’s spin-off of Topaz Energy (TPZ) which is a energy infrastructure company with a royalty business model. Tourmaline remain large shareholders.
    I’m more of a fundamental guy but I cut my teeth in the financial markets on technical analysis and haven’t forgot my stuff.

    Thanks again for an informative article.

    Reply
  • Now that we can get stock tips from Reddit do technicals not matter as much?

    Reply
  • lots of talk that last weeks selling is the start of a much bigger move down. Technically the SPX has broken out of an upchannel looks like next strong support is near 3570. Is it time to reduce risk?

    Reply
  • This comment is not about oil but another “economic sector” namely steel and associated commodities.
    I have read recently comments that say Steel is in tight supply so prices are high. Furtherdemand seems to have been high in 2020 so the likes of Russel metals and Labrador Iron Ore (LIF) have had strong run ups in 2020. Here is the question…..
    Assuming the pandemic can be improved upon such that the economy will begin recovering, why would steel benefit from this specific recovery? Steel consumers like oil patch, pipelines, and commercial buildings, in my mind are doubtful to have major stimulus to building. Commercial buildings with the stay home movement likely to remain, may have excess capacity so why build more (yes maybe condos or apartments will build). With the KXL cancelled pipeline growth YOY seems unlikely. Auto sector I can imagine growth as people begin driving more and have cash to replace their current ride. So help me understand if you think steel demand will continue high or rise as this specfic recovery evolves.
    Finally would you consider owning assets in Steel producers and Iron Ore commodity?
    Thanks as always for your insight.

    Reply
    • Thats an interesting point, so I’d just go with the charts and let them guide you. SLX is one ETF that tracks steel – it broke out recently although is testing the breakout point. Worth watching.

      Reply

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