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How Low Can Energy Stocks Go?

Posted by on Jul 28, 2015

How Low Can Energy Stocks Go?

The precipitous 21% plunge in crude oil prices in July has renewed the very bearish sentiment that was evident early in the year. The $6 billion loss reported by BP p.l.c. (BP) early this morning will not help the sentiment.

Though most of the population celebrates the low gas prices and the recent collapse in diesel prices investors who are still holding on to some of the high yielding energy giants are not happy. Many are wondering if they should sell now or just continue to hold on. Others are wondering when it will be time to buy some of these oil giants.

For example Chevron Corp (CVX) is down over 30% in the past year and lost 12% in 2014 and 6.8% in 2013. CVX had a high in July 2014 of $130.14 and based on its quarterly dividend of $1.07 was yielding 3.28%. It now yields 4.8% as it closed Monday at $89.14. Compared to the yield of 10 Year Treasuries this looks quite attractive.

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Of course in determining an outlook for the energy stocks one must carefully analyze the crude oil futures. As I noted in June the tight six week trading range in May and June was a sign that the buying power had dried up which was negative for prices.

Now that prices are approaching the January-March lows, line b, in the $44 area the questions is whether a test of these lows will just be part of the bottoming process. The more negative scenario is that the trading range, lines a and b, is just a continuation pattern. If it were completed the 127.2% Fibonacci target is at $37.50 with chart targets below $30.

The weekly technical studies for crude are negative but they are still well above the lows from early in the year. The daily on-balance-volume (OBV) topped out on June 1st (line 1) as it broke through support. The OBV is already back to the March lows and it is acting weaker than prices.

The HPI, which uses volume, open interest and prices to measure money flow also turned negative with the OBV as it violated support, line d, and the zero line. The HPI formed a strong bullish divergence at the March lows which signaled that a bottom was in place. On a short term basis the HPI is still above the July lows so a short term bottom is possibly forming.

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The Dow Jones Oil & Gas Index (DJUSEN) is the broadest measure of the energy sector.

  • The monthly chart shows that there is next strong support in the 522 area, line b, which is approximately 8.7% below current levels.
  • The long term uptrend that goes back to the 2002-2003 lows (line c) stands at 490.
  • The relative performance has been declining since early 2008 and it broke major support in September 2014 (line 1).
  • This signaled that it was acting weaker than the Spyder Trust (SPY)
  • It will make another new monthly low this month.
  • The weekly RS analysis is also in a solid downtrend and continues to make lower lows.
  • The monthly OBV has been below its WMA for the past year and shows no signs yet of bottoming.
  • There is first resistance in the 600 area with the 20 week EMA at 638.

The SPDR S&P Oil & Gas (XOP) dropped below monthly support, line e, in October 2014.

  • In each of the next four months XOP dropped below its starc- band before the three month spring rebound.
  • The monthly relative performance dropped below its support, line f, in September 2014.
  • The RS line shows a pattern of lower lows and lower highs.
  • The weekly RS line (not shown) is also making new lows.
  • The monthly OBV also broke its support, line g, last September.
  • The OBV has not yet made new lows so a bullish divergence could be forming.
  • The weekly OBV (not shown) did make a new low last week
  • There is first resistance at 441.60 and the March lows with the 20 week EMA at $4694.

What to Do: If you are not a short term scalper, bottom fishing is always dangerous. Therefore most traders should wait for clear bottoming signals before concluding that a low is in place.

For investors, scaling into a partial position in a sector is not always a bad idea. For those who feel that the economy will get considerably better before the bull market tops out some commitment to the energy sector will be warranted.

The eventual turnaround in this sector be sharp. Therefore establishing a small position in XOP or a broadly based energy ETF or mutual fund when everyone else is selling is not a bad idea.