While most investors were focused on the recent volatility in the equity markets and the weakness in the crude oil and natural gas markets, shrewd money managers were taking advantage of the low prices in the oil sector and buying undervalued stocks.
One ETF market that may have turned the corner at least in the short run is the S&P Energy Select (XLE). After reaching its lowest level since the week-ending June 28, 2013, it posted a strong rebound from last week's low at $77.51. It is currently trading close to 10% higher at $86.28.
Based on its sell-off from $101.52 to $77.51, it could trade as high as $89.52 to $92.35 over the near-term. This zone represents a 50% to 62% retracement of its 2014 range.
We can't know for certain if this rally by the energy sector ETF means that a bottom has been reached in the crude oil market, but we do know that investors haven't given up on equity stocks for their portfolios. The buying spree is likely being fueled by value-seeking money managers. The size of the rally over the short-period of time also suggests aggressive short-covering is taking place.
Typically, a short-covering rally doesn't last very long so investors should be careful about chasing this market higher. If you missed the rally then the best thing to do is wait for a retracement into more favorable price levels. Longer-term rallies usually take place after a solid support base has been formed. In the case of XLE, there is no support…
While most investors were focused on the recent volatility in the equity markets and the weakness in the crude oil and natural gas markets, shrewd money managers were taking advantage of the low prices in the oil sector and buying undervalued stocks.
One ETF market that may have turned the corner at least in the short run is the S&P Energy Select (XLE). After reaching its lowest level since the week-ending June 28, 2013, it posted a strong rebound from last week's low at $77.51. It is currently trading close to 10% higher at $86.28.
Based on its sell-off from $101.52 to $77.51, it could trade as high as $89.52 to $92.35 over the near-term. This zone represents a 50% to 62% retracement of its 2014 range.
We can't know for certain if this rally by the energy sector ETF means that a bottom has been reached in the crude oil market, but we do know that investors haven't given up on equity stocks for their portfolios. The buying spree is likely being fueled by value-seeking money managers. The size of the rally over the short-period of time also suggests aggressive short-covering is taking place.
Typically, a short-covering rally doesn't last very long so investors should be careful about chasing this market higher. If you missed the rally then the best thing to do is wait for a retracement into more favorable price levels. Longer-term rallies usually take place after a solid support base has been formed. In the case of XLE, there is no support base so this current rally is not expected to last without a meaningful pullback and the establishment of solid support.
Looking at the XLE market on a week-over-week basis, approximately $1.0 billion dollars flowed into this ETF. This represents a powerful shift into the oil sector. Over the next two weeks, we should know if this rally is an indication that crude oil has reached bottom, or is just aggressive investors taking advantage of an oversold market.
The individual stocks which make up the largest components of XLE are also trading sharply higher from last week's lows. These include Exxon Mobil Corp. (XOM), Chevron Corporation (CVX), ad Schlumberger (SLB).
Weekly Crude Oil Outlook
After reaching a low at $79.10 the week-ending October 17, December Crude Oil futures consolidated last week. Combined with the rapid rally in the oil stocks, this consolidation may be a sign that the futures market is getting ready to rally.
Oversold trading conditions and not a shift in the fundamentals may be the catalyst behind this developing bottom. Overproduction by the U.S., Russia and Saudi Arabia continue to be concerns as well as worries about low demand because of the slowing global economy.
Improvements in technology are helping the U.S. to produce more crude oil and Russia is selling as much as it can to raise cash to counter the effects of the sanctions imposed by the Europeans. This makes Saudi Arabia the wildcard in the equation.
Although most traders feel that the Saudis are comfortable with $80.00 crude oil, there are still some professional commodity managers who believe the Saudis and other OPEC members have not taken a production cut completely off the table. The rally by the XLE may be an indication that this cut may take place sooner-than-expected since stock investors usually discount future events.
Recently Saudi Arabia, Iran, Iraq and Kuwait cut prices to Asia. Although denying they are going to cut production, these price cuts may have been the first attempt to test the waters to see if demand will increase. If this idea doesn't increase demand, then OPEC members may eventually decide to cut production.
Summary
The strong rally by the oil stocks over the past two weeks may have been initially triggered by aggressive buying and short-covering, however, it may also be serving as a sign that a bottom in crude oil is near.
The rapid nearly 10% gain in XLE, the oil sector ETF, may have been a little too much, too fast so rather than chase it higher without crude oil rally support, investors should monitor the ETF and oil stocks for a pullback into more reasonable price levels. In addition. Investors should also watch crude oil futures to determine if a short-term bottom is being formed.
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