In The Short Term Look To Oil Consumers, Not Producers, For Profits

Over the last month or two, I have, on multiple occasions, expressed the view that the failure of WTI to establish itself above the $60-$62 level does not bode well for prices over the next few months. The longer that situation is maintained and the more failed attempts to break through there are, the more concerned I become. That poses a problem of sorts for somebody whose life is spent looking for trade and investment opportunities in the energy sector.

Shorting a whole bunch of energy related stocks because of that view would be one approach, but that is simply not practical for many people who have long only investment accounts rather than trading accounts. Even those who could short stock in oil related companies, however, would be taking too much risk doing so at these levels, with very limited potential rewards. That is amply demonstrated by one example. When crude oil futures hit their lows in the middle of March, Exxon Mobil (XOM) bottomed out just below $83. As I write, it is trading just above $84. Now obviously the panic selling as oil fell out of bed was overdone, but logically it makes no sense shorting the stock now to profit from a possible oil price drop, with WTI trading around 25 percent higher than at that time. It is quite possible that oil could drop back to the lows and stocks like XOM barely move.

My trading background, however, makes me averse to holding a lot of cash. If oil stays below the resistance level and even falls further I want to be in a position to profit from that. That is why I have increasingly been looking at consumers, rather than producers, of oil products.

The obvious place to look in that category is in the transport stocks, and it just so happens that there is another reason to look for investments there.

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As you can see from the above chart for SPDR Transport ETF (XTN), the sector as a whole has corrected somewhat following a strong run up as oil’s decline accelerated at the end of last year. Should oil back off further from what is looking like an increasingly strong resistance level and instead challenge the support around $50 then XTN returning to at least the highs around $111 looks extremely likely now that that correction looks to have found a bottom.

The transport sector ETF is a reasonable way to play the view that oil will drop again before recovering, but some individual transport companies may provide more of an upside. Within the sector, stocks in the airline industry have been particularly hard hit over the last few weeks as worries about possible overcapacity have added to the pressure from oil’s bounce. In reality, though, if oil does fall again and airlines are able to cut prices while still maintaining or even increasing margins, the investments in capacity that are causing the worry will look like good moves.

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A stock such as American Airlines (AAL) which has fallen a full 25 percent since March could easily gain all of that back when oil drops again, giving a potential profit of over 30 percent. Mixing a more risky play such as this with a position in the broader, less volatile ETF looks like a good use for any cash.

You may remember that just over a month ago, I recommended trimming some positions in energy stocks as oil first struggled to break cleanly above $60. Oil and other energy related stocks have generally declined since then, but it is still too early to be buying back in; any further drop in oil may not push those stocks much lower but it will certainly limit any upside. It doesn’t make sense to either buy or sell oil stocks here, so you are left with cash looking for a home. If you are like me and holding cash in your account seems like a bit of a waste, parking some of that money in transportation stocks for a few months could be the answer.