The energy sector may hold the next big trade
Published: Nov 25, 2014 9:26 a.m. ET
Staying on the right side of the market isn’t simple, but it’s not impossible either. Over the past two months, we witnessed a short-term market top, a plunge and washout bottom and now another violent “V”-shaped rally to new highs. Predicting this turn of events was virtually impossible, and if anyone actually predicted it, then they should head down to the local drug store and pick up a lottery ticket. But one doesn’t have to predict to profit. That correlation is not necessary. You just have to see when risk is increasing — up or down — and position appropriately. You need to recognize where opportunity lies across the many trading and investment opportunities available to you and seize it.
Reducing risk near the highs, then adding some of that exposure back at the washout lows and later as the bearish retest and regenerate failed to stop the advance, are the latest examples of neoclassical reads — pure tape reading focused on how supply and demand line up. These reads are not limited to equities only, but apply to all markets where volume, time and price are available for analysis. This includes currencies by examining their ETF proxies. As recently stated, almost all currencies were set to devalue relative to the dollar and were doing so even before China and Europe teamed up late last week to push them even lower. A reading of the tape had already told us this was coming, so a further devaluation in the euroshould not have been a surprise. Supply and demand do rule.
So where might the next opportunity to stake out a potentially larger directional trade be?
One possibility is energy equities. The energy sector has easily been one of the worst-performing sectors. Whether you are looking at the large-cap integrated oilsor the drillers, the carnage has been absolute. A 30% decline in the drillers in less than half of year is a testament to just how bloodied the group is. But where there is pain, there eventually will come relief. The key is to be patient enough until the supply/demand equation starts to turn and the formation of bullish patterns develop.
If we look at the commodity that is the root cause of the pain in this sector, it has finally begun to show signs of supply/demand equilibrium. Although these first signs of a tentative turn are now evident, we still do not yet have enough information to know that the bearish plunge in prices has bottomed and some sort of range trading is now in order. The chart tells us that we are at a point where this potentiality can take root.
OPEC is slated to meet the end of this week. Saudi Arabia has been reluctant to pull back production short term as their longer-term goal seems to be to fatally wound the fracking competition — to make it untenable for the U.S. producers to continue to drill in this fashion. In the process, they are wounding the OPEC community. The market at least senses that a potential turn is at hand. The confirmation that a turn is at hand would be for the bearish retest-and-regenerate zone to fail, indicating that a range trade is most likely on this time frame.
Clearly, the market has discounted a lot of the effects of the oil plunge in those companies tied to it, be it the drillers or the large-cap integrated oil concerns. But again, here we are seeing signs of a potential turn as well. With the drillers and the integrated oils, price has refused to trade lower, in spite of the commodity doing so over the past five weeks. Here’s a chart of the integrated concerns which are clearly trending higher now.
A glance at the drillers charts shows that they too are refusing to move lower anymore.
Any way you look at it, the potential for a bottom looks high as does a press back to even higher prices. Of course, one has to pick their spots to make the money and risk management work, but in a mature bull market; one that has just witnessed another fast stretch higher, rotation into the lagging groups is the norm, not the exception and this group finally looks like it may be primed for some of that action.
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