Thoughts On The Energy Sector

A reader asked me today what I thought of the energy sector and if I would look at it using Stage Analysis.  I have been noticing some energy stocks appearing on my stock scans, and that hasn’t happened in quite a long time so that’s a positive.  But here’s what I’m not seeing that hasn’t made me want to load up on energy stocks yet:

  1. Large number of energy stocks across the sector breaking out to new highs on big increases in volume
  2. Energy stocks outperforming the S&P 500 and other sectors
  3. Crude oil in an uptrend
  4. Commodities as a group in an uptrend (I tend to use the GCC ETF to view that)

Here’s a longer term chart of XLE.  A couple of things to note on this chart.  I’d rather see a nice long base here to launch into a new bull market, but all we have so far is a bounce higher from the 2016 bottom.  I could see energy stocks basing for a while longer here and digesting the previous bear market.  I want to see XLE outperforming the $SPX on the middle section of the chart too, and that’s clearly not the case.  If you look at semiconductors or biotech (SMH or XBI) you’ll see the exact opposite of what you see here and that’s why I like those sectors right now.

I actually did recently trade one energy stock WTI because I liked the chart but I didn’t trade it as a sustainable uptrend.  Maybe I’ll be wrong and energy stocks have bottomed here but I don’t see that yet in the charts.  On this chart of WTI though you can see how we have a nice Stage 1 base that it exploded higher off from on massive volume.  But notice how it did the same thing in late 2016 only to turn out to be a fake rally that failed.  I wouldn’t be surprised if the same thing happens here unless we see more strength across the sector.

I see the same thing in energy in other commodity sectors like gold stocks.  A few stocks breaking out higher but that tends to be the exception more than the rule.  That was why I didn’t think the August to September rally in gold was going to lead to a new rally as well, I saw a lot of gold stocks acting terribly when they should have been gearing up for a big move.

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Week In Review

The major indexes were slightly down last week, but the Transports had a more significant pullback down –2.65% for the week.  Commodities were the outperforming part of the market last week with oil up 4.61%, copper up 5.71%, and silver surging up 8.28%.  The powerful moves in commodities were aided by the declining dollar, which slid down –1.29% for the week.

Gold and gold stocks finally broke out of 5-month consolidations last week.  This is very bullish for gold and gold stocks.  The fact that the dollar is breaking down from a multi-year consolidation could add extra power to the near term potential for gold and gold stocks.  The dollar continues its breakdown from its lower trendline support out of its 2008 low and also continues to decline below a falling 30-week moving average.

Silver is continuing its powerful move despite stretching further and further away from its long term moving averages.  This is keeping many investors who would prefer buying pullbacks out of the silver market and on the sidelines while silver keeps marching higher.  Even though silver may be overbought, it will be hard for it to have a major pullback while gold is just starting to breakout again, and the dollar is breaking down from a long consolidation.  As long as those two drivers of the silver price are still in place look for silver to continue rallying.

Oil started accelerating its uptrend in March and hasn’t stopped since then.  This is eventually going to become a problem for the markets if oil continues to rally at this pace.  Watching the performance of oil sensitive sectors such as the Transports should provide telling clues as to the overall impact of higher oil prices on the market.  One thing to note about the current price of oil is that even though oil is still over 20% from its all-time high in 2008, gasoline is less than 10% from its all-time high.  This outperformance of gasoline versus oil has likely contributed to good performance by refining stocks over the past few months.

The falling dollar is being confirmed by a new breakout in the Euro above a multi-year downtrend line.  The Euro is also rallying above a rising 30-week moving average which is bullish for the Euro.

Bonds are also being affected by the falling dollar as they have been unable to rally back above their respective 30-week moving averages.  More significant technical damage will be done to bonds if both the 30-year and 15-year fall below 115 on the chart, which has been a multi-year support level.

Gold and Oil Should Outperform as the Dollar Continues to Fall

Some financial commentators have picked up on the fact that the dollar has failed to get a safe haven bid so far during the turmoil in the Middle East. This isn’t normal, especially considering the problems one of the main alternatives to the dollar, the Euro, has had over the past year or so. The dollar was the recipient of two separate flights to safety over the last 3 years, one during the financial crisis in 2008, and one during the Euro crisis in 2010. But since peaking in 2010 the dollar has steadily trended lower, even during the current crisis in the Middle East.

The chart below takes a long term look at the dollar, and shows the last major downleg from late 2005 to early 2008. Notice how the current chart pattern in the dollar is similar to the rounded top the dollar formed in 2006, before breaking down into Part 2 of the downleg. The dollar is also currently declining below a falling 30-week moving average, just like it was in 2006 before it broke the support line and started to accelerate its trend lower.

During Part 1 of the last major dollar downleg, from November 2005 to November 2006, the broad market including the S&P 500 and Nasdaq went higher along with commodities, gold, and oil. Clearly all asset classes, including stocks, were benefiting from the decline in the dollar.

The same thing has happened so far during the current dollar downleg from the June 2010 high.  The major indexes are up strongly along with commodities, gold, and oil.

During Part 2 of the last major dollar downleg, from November 2006 to March 2008,  the major indexes actually fell while the dollar lost 15% of its value.  This was in part due to the financial sector topping in early 2007, but is still a dismal performance when combined with the value lost in the dollar.  Commodities on the other hand, and more specifically gold and oil, performed exceptionally well and handily made up for the value lost in the dollar.

The outperformance by gold and oil over general commodities in Part 2 of the last major dollar downleg can also be seen in the next two ratio charts comparing gold and oil to the commodities index.  Notice that oil initially underperformed commodities during Part 1 of the downleg but came roaring back and outperformed dramatically in Part 2.

In the current dollar downleg so far, both gold and oil have underperformed general commodities and are also coming off of 2-year lows against commodities.

Given the undervaluation of gold and oil against commodities currently, they could easily switch gears and outperform commodities if the dollar breaks support and continues to trend lower.