Don’t Give Up on Oil Yet
Oil and oil stocks are out of favor – but not on their way to oblivion. Investors should wait for buying opportunities instead of selling off.
By Michael Kahn
There’s no doubt about it: Crude oil was trounced last week and its three-month period of stability was clearly broken to the downside. The question is whether this is the start of yet another collapse in prices or merely a market adjustment within a new normal.
Based on the charts, it looks to be the latter – that is, a decline within the larger trading range between $40 and $55 per barrel, which has arguably contained the market for the past two years.
First, I have to explain why I think $40 is the low end and not the $26-$27 area seen a little more than a year ago (see Chart 1). If we construct the range using absolute highs and lows, we might get something a bit more mathematically pure yet far less useful. Rather than dwell on creating a pretty picture, I’d rather look at price levels that actually got bulls or bears to step up their game.
And that points to potential buying opportunities ahead. I just don’t think they are there right now. We should wait until the bottom of the range and technical support are reached.
Some may argue that the trend from early 2016 is still unbroken to the upside, and indeed, we can draw a trendline to support that idea. I counter by saying the required series of higher highs and higher lows is not really there. Most of last year was actually spent churning about, even with November’s big rally on news that OPEC was cutting production by 1.2 million barrels a day, causing the prices of oil and oil stocks to jump.
In other words, the past year of activity resulted in more of a trading range than a rising trend.
Last week, oil dropped $4.81 to 48.39 per barrel -- its lowest weekly close since the end of November. In the news was the U.S. Energy Information Administration reporting a ninth consecutive rise in crude inventories. This came as Saudi Arabia’s energy minister said the OPEC agreement was not making as quick an impact as initially anticipated.
Of course, oil can bounce anytime, especially since it sits, arguably, on the trendline as well as the 200-day moving average. The latter is not usually a major analytical tool for crude oil, but the market did bounce off it twice last year. If oil-trading bulls believe it was meaningful before, then they may buy now.
Still, the big picture, as seen in the long-term chart, remains a trading range (see Chart 2).
The same is true for oil and gas stocks, although I think we have to give a lot of credit to the broader stock market for preventing a short-term breakdown from turning into a bigger problema.
In a February column, I called energy stocks undervalued and ready for breakouts. I saw a big bullish reversal in the Energy Select Sector SPDR exchange-traded fund (ticker: XLE) at an important support level, which failed to follow through with much upside (see Chart 3). Mea culpa – but to be fair, I did point out that a trendline needed to break to the upside before the buying should begin.
That breakout never occurred, and the ETF continued to slide into last week’s lows. Even worse, the trendline from the January 2016 low, which defined a much better rising trend than that for crude itself, broke to the downside, as did key horizontal chart support.
In the past 13 weeks, the ETF gave up nearly all of the relative gains it had made against the Standard & Poor’s 500 index since January 2016. That’s some serious underperformance.
Along with support breaks, we can add a 200-day average breakdown, which does have meaning in the stock market. The potential for more losses is very real.
Still, measures of “cumulative volume” and “accumulation” suggest that investors are not selling their shares in a panic. Instead, it seems to be more of a buyers’ strike. The rising tide in the broad market seems to be supporting energy, even though that sector seems so weak. That may be outweighing the supply issues seen in crude oil. Even a lagging sector can move higher if the broad market is strong enough.
The bottom line is that both oil and oil stocks are out of favor right now, but the charts do not offer enough evidence to say that will bring them down to new lows. It may take a while to play out, but it looks like the best strategy for investors is to wait for buying opportunities to emerge rather than purging portfolios of oil and oil stocks completely or selling them short.