Buying the Dip in Energy?

It’s been a rough few days for energy stocks and like all of you, I feel the urge to do some prospecting. But before I go full Daniel Plainview, I need to stop and think about the attractions of energy stocks and what’s working for and against the trade and to quote Jim Cramer in Arrested Development, I’d have to say they’re a resounding “Don’t Buy!”

Perhaps the biggest item in the pro column is that West Texas Intermediate Crude is right back to where it started 2014 as North American production coupled with falling tensions in Europe and a U.S. backed effort to keep Iraqi production out of the hands of Sunni militants seems to have done its job. But then again, WTIC is a cruel cruel mistress and tends to have a seasonal pattern. Let’s check in on a weekly chart to see what’s what:

WTIC

Well as an Egyptian friend of mine used to say, “craps%$t.” Yes, no one ever had the heart to tell him he was saying double crap. That can’t be good, let’s switch gears and check out Brent Crude and our friends at the Short Side of Long to see what they say.

Brent
Double craps$%t.

So the trend isn’t going in the right direction there. What else could be working against us? Well since the Euro and Yen have been losing ground in 2014, uncle Buck has been (and has to be) advancing in the right direction and starting a new pain trade for gold, oil and anything else you care to think off. Here’s a chart showing the USD’s advance versus the pain of the Euro and Yen. Yes, the dollar may appear to be overbought but remember currencies are a relative game. As long as people don’t want Euro’s, they’ll buy dollars and it can go for as long as it wants. Never stand in front of a stampeding crowd.

USD

Now that we’ve established all the reasons going long energy won’t work, let’s talk about why there’s still hope in the energy trade using XLE on a short-term basis. Let’s go down the list:

  1. Now that every hedge fund, macro trader, CNBC watcher is long the dollar, we should expect the buying pressure to ease. Especially given Draghi can’t get the Euro to parity with the dollar overnight and all by himself. Going to be a long process people.
  2. Technicals are favoring long energy, but most likely for only a short term trade.
  3. The Yinzer Analysts momentum models show XLE back to where it was at the start of August.
  4. There’s always less risk AFTER the price heads lower – as long as you can keep a close eye on positions.

But all things considered, I’d stay away from energy stocks and would use a bounce to cut my losses, not add to existing positions.

Skipping to item 2, let’s take a short and intermediate term picture for XLE.

Short-Term (1-2 Weeks)

xleD

Using daily charts, XLE looks to be stuck in a descending triangle, typically a bearish pattern indicating distribution. We have two lower highs to form the upper boundary of the move and nearly two equal lows to form the base at around $95. If you check out the 20 day CMF score at the bottom of the page, you’ll see that the August bounce was more about an exhaustion of sellers than an influx of buyers. What’s working in the favor of going long? The RSI is nearly back to oversold territory while XLE is closing in on strong support. If it doesn’t hold at $95, the next support is back at $92.50.

What to watch for is a one day bounce followed by distribution on day 2 to retest support and allow for more of this year’s buyers to sell out. If we do hold at $95, the most likely point to think about setting a trailing stop is at $98 or approximately where the upper boundary will be over the next week. That only leaves about 3.16% upside potential for a potential downdraft back to $92.50 of 3.14%. Not too exciting.

The Yinzer Analyst’s momentum models show XLE back to where it was on August 1 on a short term basis, as the trailing 1 year score has fallen into the bottom decile. That low point resulted in a 2% move over the next 30 days and longer-term scores have fallen even further offering hope we could get a more substantial bounce.

To time my trades, I’d wait for the 5 day exponential moving average to cross under the 10 day and begin moving higher, even though that might mean missing out on 50 cents, which in this trade could be a substantial portion of the upside potential. Here’s the short term trade again with the simple moving averages changed to those exponential lines and you can see that waiting for confirmation from the 5 and 10 usually leads to happier outcomes.

xled2

Longer-Term (3-6 Months)

XLEW
Looking further out using weekly charts, XLE is even less exciting on a long-term basis than a short-term one. XLE spent most of 2013 in a terribly unexciting uptrend channel that put points on the board in a very unsexy manner. You made money but still lagged the S&P 500 but then 2014 gets off to a bang. Besides the typical sector rotators buying whatever is cheap and trying to justify their fee’s with active management, you get a second tier terrorist threat trying to push its way into the Premier League plus Putin, who is downright scary. And oil does love uncertainty. But the buying pressure has eased and the pattern is uncertain. Could we be in another channel consolidating gains? On a weekly basis, the RSI score over the last 14 weeks is just getting back into neutral and not screaming “buy me now.”

xlespy
Take a step back and compare the performance of XLE over the last few years with the S&P 500 and you’ll see a familiar pattern. The falling wedge, typically bullish and replicated by utilities and consumer staples as they’ve lagged the broader market for 3 years. Ending today, XLE has an annualized return of 15.67% versus 21.51% for SPY. No wonder everyone went gaga over it this year but it was the late comer to the party. XLU and XLP started the year stronger while XLE was fashionably late and arriving in March.

Looking at this chart, you can see XLE has given up all the ground it made against the S&P 500 this year and is nearly back to its relative momentum starting point. It might need some time to cool off before it can start a new, long term trend.

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