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Jim Hyerczyk

Jim Hyerczyk

Fundamental and technical analyst with 30 years experience.

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Time to Sit Back and Plan Your Next Investment strategy

With crude oil and crude oil-related stocks exhibiting nearly free-fall characteristics, unless you’re willing to play the short-side after an almost three month sell-off, this week it may be best to sit back and plan your next investment strategy while waiting for the markets to reach strong value areas.

This week’s sell-off in crude oil and energy stocks was strong enough to pull the rest of the U.S. stock market down. This is a sign that money managers are beginning to sit up and take notice. Investment managers may have been complacent throughout the year because the liquidity provided by the Fed made equities the best game in town.

Stable and up trending crude oil prices may have also been looked upon as signs of an improving economy. Even the early break from the high in June may have been perceived as good news because many economists and analysts may have read this weakness as good for the economy because it led to lower gasoline prices which is beneficial to the consumer.

With nearby crude oil trading at 50% of its two-year range and a few of the oil-related stocks rapidly approaching 50% of their 2014 range, now may be the time to start planning a strategy to take advantage of stock prices that may be trading in a value zone at the same time crude oil reaches a bottom.

Financial Market chart 1 

Since these oil stocks are highly correlated with the price of a barrel of crude oil, there is a strong chance that a turn in the price of crude oil will help put in a bottom in stocks related to drilling and exploration. These include Newfield Exploration (NFX), Nabors Industries (NBR) and EOG Resources (EOG).

Financial Markets Chart 2 

Keep in mind that this is a highly speculative strategy because crude oil is showing no signs of bottoming at this time. The drop in crude oil prices is also becoming a bit of a drag on the entire S&P 500 Index. Earlier in the week, the broadly-based index was down 0.3 percent while the energy component of the S&P 500 declined 1.6 percent.

While some traders cite the easing of geopolitical events in Ukraine as the current reason for the weakness in crude oil, the strongest influences since late June has been overproduction and low demand. Also impacting the price of crude oil has been the uncertainty about China’s economy. A recent report from this country showed a slowdown in manufacturing.

Some traders cite the unrest in Iraq as one reason why crude oil hasn’t plunged further faster, but until there is a disruption in supply the conflict will have a minimal effect on prices. On Wednesday night, President Obama vowed to step up military action in Iraq. This may lead to an eventual disruption in supply, but this is still highly speculative.

Now let’s take a look at the bearish side of the market. Two key reasons for the drop in crude prices since late June are fast-rising U.S. output and the return of exports from Libya. These two factors are contributing to a serious oversupply situation. OPEC is claiming that it had cut production, but recent data shows total production had actually risen in August. The oil cartel has the power to put a dent in the global supply situation, but there has to be cooperation among all members to actually succeed.

The long-term outlook doesn’t look great for oil producers either.  An OPEC report from earlier in the week, cut expected demand for crude oil by 160,000 barrels per day in both 2014 and 2015. Earlier this week, the U.S. Energy Information Administration (EIA) said that U.S. output in August hit its highest level since 1986. Adding further to the expected weakness is the EIA forecast that calls for imports to drop to just over 20 percent next year. This is down from almost 50 percent in 2010. So what we have at this time are predictions of lower demand and rising production. This can’t be good for crude oil prices over the long-run.

Despite the plethora of bearish fundamental news, Nearby Crude Oil futures are currently trading inside a two-year retracement zone that could provide near-term support and stop the slide. This zone is bounded by $91.40 and $87.77. Investors should watch for consolidation inside this zone over the next few weeks.

The first oil-related stock to watch is Newfield Exploration (NFX). Its weekly chart suggests the best value area is $34.50 to $31.92. This zone represents 50% to 61.8% of its 2014 range.

Nabors Industries (NBR) is another stock to watch closely. Its potential downside target and support zone comes in at $23.39 to $21.77.

Financial Markets Chart 3 

Finally, EOG Resources (EOG) is currently testing 50% of its 2014 range. Money managers may find this stock attract between $99.76 and $95.25. Traders should watch this stock closely for bottoming action over the near-term.

Financial Markets Chart 4 

In conclusion, crude oil fundamentals are overwhelmingly bearish, but the futures contract and three oil-related stocks are at or nearing areas that could be considered value zones. It is not being suggested that investors should jump in front of a falling market, but if the rate of descent in these markets begins to slow down, or if they begin to form support bases then it may be the right time to take advantage of a buying opportunity.

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