Revisiting the energy trade as the Jackson Hole meeting concludes

August 25, 20222 Comments

Periodically, I get questions asking if “now” is the time to go back into the oil trade. Today, I will offer some of my views on the timing of this decision.

 

Some background to oil’s price decline, and a reason for probable upside in the coming months

I noted that (to quote myself) “Energy is way overbought”  back in March.  I hope you paid attention to that message. We reduced our energy stock exposure from about 30% to about 6% by the late spring. That move turned out to be prudent, having captured large profits in the sector before it fell. WTI oil slumped 27% since mid-June amid concerns about the global economy, surging shipments from Russia and the possibility of more Iranian oil coming back online in the event of a nuclear deal. It recently fell under $90 per barrel, although it has recovered since. We kept a 6% exposure to 2 gas-focused stocks.  They have done quite well – outperforming the oil-focused stocks we sold.

Understand that, all along, I have remained an oil-bull. But energy  stocks (oil focused in particular) were overbought in the spring, and it was prudent to take some profits. Please understand that we fully intend to go back into the sector aggressively. But only when the time is right.

Here are some comments that I copied from a Seeking Alpha morning update regarding why prices have declined. More importantly, I’ve highlighted important comments made by Saudi Arabia’s oil minister suggesting why the future may be bullish for oil.

Saudi Oil Minister Prince Abdulaziz bin Salman recently noted that “Thin liquidity and extreme volatility” in the futures market are moving prices in ways that do not conform to normal supply and demand factors. 

He implied that action may spark OPEC+ to take action, including tightening production when it meets next month.

“The paper and physical markets have become increasingly more disconnected,” Abdulaziz bin Salman declared, adding that forces which “undermine the stability of oil markets will only strengthen our resolve.” Efficient price discovery is absent without sufficient liquidity, making it challenging for physical users to handle the costs of hedging or deal with fundamental risk. “Soon we will start working on a new agreement beyond 2022,” he continued, without giving further details.

“This vicious circle is amplified by the flow of unsubstantiated stories about demand destruction, recurring news about the return of large volumes of supply, and ambiguity and uncertainty about the potential impacts of price caps, embargoes, and sanctions. In a way, the market is in a state of schizophrenia, and this is creating a type of a yo-yo market and sending erroneous signals at times when greater visibility and clarity and well-functioning markets are needed more than ever to allow market participants to efficiently hedge and manage the huge risks and uncertainties they face.”

WTI chart

OK, lets now take a look at the technical profile of the major energy sectors. WTI is below the 200 day / 40 week SMA. The trend is weak. You’ll also notice the bearish neckline break on the chart. I’d want to see a move back above the neckline before considering a trade. Note, too, the momentum oscillators are bearish all around.

Natural Gas

I noted above that we kept 6% of our holdings in gas-orientated producers. You can see on the Nat Gas commodity chart below why we held that position, despite our outlook (at the time) for oil. A new breakout, its maintaining above the 200 day/ 40 week SMA, momentum is bullish across the board. We’re not selling.

Energy Producers

The setup is different for the producers than it is for WTI crude oil (top chart).  The energy sector – seen via the iShares XEG ETF,  holds some “gassy” stocks.  But the holdings are primarily oil stocks. Its starting to look attractive to re-enter the oil trade via energy stocks. Note that – unlike the broad indices – energy has maintained its price over the 200 day / 40 week SMA. The trend is weak, but does not meet my criteria for a breakdown or bear market. You’ll also notice the bullish neckline break on the chart. Note, too, the momentum oscillator hooks. Bullish all around.

This chart tells us that producers are leading the way (forward – looking?). That’s bullish, but I would prefer to see WTIC reverse course and add further proof to the trade before getting too enthusiastic about the trade.

Seasonality

WTI tends to experience its best period in the early winter to the spring.

 

The producers can move a bit early, often having a nice pop in December. In either case, energy tends not to do much in the fall – at least from a seasonal perspective.

Conclusion

We want to buy back into the energy sector, specifically oil producers. But we are willing to wait for more technical evidence – particularly on the crude oil side of the trade. Once we get a WTI price move above its neckline, that indicates confirmation of the producers recent bullishness. At that point, we will start to get back into the producers – one step at a time. The Fed is meeting at Jackson Hole right now to discuss rates. The outcome of that meeting, and future monetary policy and recession potential will impact oil prices as well. Markets will digest the comments over the coming days. So I think its wise to sit out of the trade just a while more.

I hope that helps answer readers questions regarding the energy trade. The background is there for a move – both fundamentally and technically. We just need confirmation – per my notes on the charts above.

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2 Comments

  • so hear is a technical analysis question.
    There is an agriculture sector stock that has the following characteristics….
    – Full stochastics and MACD are moving upwards. Means there is momentum upwards
    – RSI has just moved to over 70 meaning we need to be cautious but it can still rise further.
    – but here is the kicker…. Volume is low implying there is no conviction to the rise, that smart money is not pushing it higher.

    So my conclusion is that with no real volume this stock would be at risk of stalling, or pulling back at the first sign of market softening. It would imply watching carefully and if the market were to appear to be stalling, this one is going to retrench fairly hard, and if we believe like you that this may be a bear market rally, then exit it.
    Thoughts on my technical read of key technical indicators you have instilled in us?

    Reply
    • I assume this is as you say, a stock and NOT an ETF. True, your observations are valid if its a stock (but remember that trend is the most important factor–support resistance etc-momentum indicators are neartermed signals). Anyhow–good work, you are thinking correctly. If its an ETF–volume means nothing, as they trade off of their NAV and keep reasonably tight by the market maker–so it doesnt matter what the volume is as far as price goes except for interim spikes here and there

      Reply

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