How To Capitalize On The Latest Oil Drop
By Martin Tillier - Jul 10, 2015, 3:44 PM CDT
As those who have been reading my ramblings over the last few weeks will be aware, I have been saying that the failure of WTI to break above the $62 resistance level left oil vulnerable to a sharp move down to test support levels in the mid to upper $40s. That move started this week, prompted by the Greek “no” vote and the continuing woes in China, and when it came, it was pretty spectacular. Hopefully you have all been listening and have trimmed positions, leaving you sitting on some cash. The question now, of course, if should you start deploying that cash?
Unfortunately, the answer to that question is a somewhat unsatisfying “maybe”; a qualified yes, if you will. As you can see from the chart below, WTI’s most recent decline has halted at around $52. As a result, many of the stocks that you might consider buying into, or back into in some cases, will have bounced somewhat on that halt and fear of missing the boat makes rushing in now a strong temptation.
As somebody with a trading desk background, however, when I look at that chart the temptation I see comes from the proximity to the January and March lows of around $49. I am sure others see it the same way, so any hint of more bad news should prompt a test of those levels, and there is a lot of potential for bad news.
Firstly, a deal of some kind that ends sanctions on Iran looks extremely likely as talks continue. It should be noted that even if a deal is struck it…
As those who have been reading my ramblings over the last few weeks will be aware, I have been saying that the failure of WTI to break above the $62 resistance level left oil vulnerable to a sharp move down to test support levels in the mid to upper $40s. That move started this week, prompted by the Greek “no” vote and the continuing woes in China, and when it came, it was pretty spectacular. Hopefully you have all been listening and have trimmed positions, leaving you sitting on some cash. The question now, of course, if should you start deploying that cash?
Unfortunately, the answer to that question is a somewhat unsatisfying “maybe”; a qualified yes, if you will. As you can see from the chart below, WTI’s most recent decline has halted at around $52. As a result, many of the stocks that you might consider buying into, or back into in some cases, will have bounced somewhat on that halt and fear of missing the boat makes rushing in now a strong temptation.
As somebody with a trading desk background, however, when I look at that chart the temptation I see comes from the proximity to the January and March lows of around $49. I am sure others see it the same way, so any hint of more bad news should prompt a test of those levels, and there is a lot of potential for bad news.
Firstly, a deal of some kind that ends sanctions on Iran looks extremely likely as talks continue. It should be noted that even if a deal is struck it will probably not lead to an immediate flood of Iranian oil into the market, but perception, not reality, is what matters here. Any hint of increased supply into an already over-supplied market would be a catalyst for a further decline.
Even if no deal is reached quickly on that front, tales of the effects of China’s market crash on growth there are likely to be common over the next few weeks, raising questions about global demand. Again, from a long term perspective we are really talking about a reduced rate of growth in oil demand, not a massive decline, but those stories as they emerge will embolden sellers.
All things considered, therefore, a push to test the lows below $50 looks more likely than a recovery from here. Even so though, a strong argument can be made for beginning to deploy some cash. If those lows are tested, we are talking about a decline of around 5 percent from here but if a deal is arrived at this weekend in Europe and/or the Chinese collapse looks to have played itself out, then a steady climb back up is on the cards, with a long term goal of around $70 for U.S. crude. Those targets make the risk/reward calculation favor beginning to buy now.
Dollar cost averaging into a selection of mid-sized and large E&P and integrated companies over the next few weeks looks to be the best strategy from here. That would allow for picking up stocks even cheaper if the test of the mid $40s comes as I expect, but would give you a solid base from which to accumulate positions if the newly formed $51-52 support holds.
Either way you won’t be wasting the opportunity to buy energy stocks at a discount, and that is the key here. Analysts’ estimates for earnings have caught up with the lower oil price, and in many cases reduced production, so the upcoming earnings season is likely to be neutral in the average, or could even provide some relief for beleaguered energy stocks. Much of this move has been about short-term news and trader sentiment, so the old adage that the best cure for low oil prices is low oil prices suggests that once the dust has settled, stocks picked up at these levels will, with hindsight, look like bargains. The best advice, then is to begin buying now, but don’t put all of your eggs in one basket.
