|
The recent recession-fear craze hammered commodities
prices, crushing the stocks of the companies that produce them. Commodities stocks were wholesale abandoned
by frightened traders, left bludgeoned and bleeding. But driven to deeply-oversold levels,
they got incredibly cheap relative to their underlying fundamentals and
bull-market precedent. Oil stocks
are a shining example of this great opportunity.
Crude oil is the king of commodities, and the
companies that produce this essential resource enjoy a unique position. As the world’s only meaningful
transportation fuel, oil is the foundation of this entire planet’s vast
and complex logistics network.
Oil truly is the lifeblood of our global economy, as without it nothing moves. And if goods can’t be shipped,
stores have nothing to sell and we all starve to death.
Once oil is consumed, it is gone forever. So huge quantities must be produced
every single day to ensure the world doesn’t grind to a halt. And oil demand is remarkably inelastic, the
world continues to voraciously consume enormous amounts whether traders as a
herd are euphoric or terrified.
But though oil’s strongly-bullish underlying supply-and-demand
fundamentals persist, traders’ unchecked emotions often wildly batter
the oil price about.
Oil’s fundamentals have driven a powerful
secular bull that started way back in late 2001 (at around $17 per
barrel). Because global demand
growth has continued to exceed global supply growth, oil prices have climbed
on balance. Think of the
fundamental impact in oil-price terms as a
straight line slowly rising from left to right on a chart. Since it takes many years for
fundamentals to change, their price impact is quite gradual.
But superimposed on top of these core fundamentals
is the psychology of traders, which imparts great volatility to oil prices. Traders as a group perpetually
oscillate back and forth between two emotional extremes, widespread greed and
widespread fear. When they get
greedy, they rush to bid up oil prices too far too fast. When they get scared, they scramble
for the exits and drive down oil too far too fast.
This collective greed and fear pulls and distorts
oil’s fundamentally-driven straight-line secular-bull ascent. When greed reigns, oil prices are
pushed too high relative to their underlying fundamentals. When fear reigns, they are pulled too
low. So instead of a nice
straight line, oil’s secular bull has
looked like a sine wave oscillating
around a straight line. Greed
eventually fuels big uplegs which get overbought
and fail, spawning big corrections that soon get
oversold and burn themselves out.
All bull markets experience these same upleg-correction cycles, created by the same ubiquitous
greed and fear in traders’ hearts.
And as oil gets overbought and oversold, oil stocks amplify these
moves in the commodity they produce.
This reaction is certainly logical. Oil stocks have great profits leverage
relative to the oil price, and it is profits that ultimately drive any
company’s stock price.
In recent months oil has weathered a major
correction, one of the largest ones of its entire secular bull. With oil down so much, oil stocks have
naturally been sold aggressively.
This has pounded them to deeply-oversold levels very disconnected from
the underlying fundamental reality that drives their long-term profits. Thus there is an amazing (yet fleeting)
opportunity today to buy elite oil stocks at bargain prices.
While many indicators can measure overboughtness and oversoldness,
reflections of excessive and unsustainable greed and fear respectively, my
favorite is Relativity. I created this simple trading system
many years ago to help hone my timing.
It looks at prices relative to
their underlying 200-day moving averages. Since 200dmas are slow to change, they
are a perfect baseline from which to measure how far and fast any price has
moved.
Relativity multiples are computed by dividing a
price by its 200dma. Charted over
time, this multiple forms a horizontal
trading range. When a price
gets too high relative to its 200dma, it is overbought so prudent traders
ought to layer out and realize their profits. When a price falls too low relative to
its 200dma, it is oversold so traders ought to layer in to buy low. Relativity reveals both oil and oil
stocks were recently as oversold as they’ve been for years, an
incredible buying opportunity.
2008’s crazy stock panic was an epic
discontinuity disrupting every commodity’s secular bull, so it is most
useful today to limit this analysis to the post-panic years. Since bottoming around the secondary
stock-panic low in early 2009, crude oil has enjoyed two massive uplegs and weathered two major corrections. But despite this greed-and-fear-driven
volatility, it has still clearly risen on balance as its bullish global
supply-and-demand fundamentals require.
In its recent correction, oil surrendered nearly a third of its value after hitting its
latest interim high in late April.
A 32.4% correction certainly sounds gargantuan, but incredibly for
usually-volatile oil it is not too exceptional. Back in 2003 and 2006, well before the
stock panic in 2008, oil experienced even bigger healthy-bull-market corrections of
33.3% and 34.5%. So this
particular commodity falling by a third or more certainly doesn’t
imperil its secular bull at all.
Interestingly, oil tumbled back down to some major support levels during its latest
correction. Near $77 per barrel
last week, it was again at prices first seen in this post-panic era in late
2009. And it also hit its major
post-panic support line established during its last correction in spring
2010. So from a classic
technical-analysis perspective, oil is definitely now trading around levels
likely to spawn its next major upleg.
But absolute prices aren’t particularly
important for trading, relative
ones are. And the Relative Oil (rOil) construct really drives home just how oversold oil has
been. If you took oil’s
black 200dma line above and flattened it to horizontal, and then rendered the
blue oil price as a multiple of that 200dma (which is perfectly comparable
over time in percentage terms), the result would be the light-red rOil line slaved to the left axis. It has indeed formed a distinct
horizontal trading range.
At Zeal we base these Relativity ranges on the latest 5 calendar years of price
action. If you are a subscriber,
you can log in to our website and see the large high-resolution charts
(updated weekly) that we use to define our Relativity ranges. Crude oil’s relative range now
runs from 0.90x on the support side to 1.35x on the
resistance side. In other words,
oil tends to trade between 90% of its 200dma when it is oversold and 135% of
its 200dma when it is overbought.
These oversold conditions are seen after normal
healthy bull-market corrections.
Late in oil’s last correction in spring 2010, rOil fell to 0.906x. Ironically back then, traders were
scared that a Greek default and
China slowdown
would somehow seriously retard global oil demand. Sound familiar? Yet technically oil was simply
oversold, it had fallen too far too fast to be sustainable. And indeed over the subsequent 11
months or so, oil powered 63.9% higher in another mighty upleg.
During its latest correction, the oil fear was even
more extreme so the resulting oversoldness was
considerably greater. rOil didn’t bounce at its
0.90x trading-range support, but kept on plunging. This key metric hit 0.845x in early
August the day the S&P 500 correction initially bottomed, and 0.808x last
week when the stock markets hit their marginal new secondary low. Oil was radically oversold both times!
In fact as this chart reveals, oil fell so far so
fast that it was as oversold as it has been since emerging out of its secondary stock-panic lows in early
2009! And those lows were brutal, oil was merely trading at around $45 back
then. Wouldn’t you have
loved to have gone long oil stocks as we did near those levels? I suspect a year or two from now,
traders will wistfully look back at today’s cheap oil and feel the same
regret.
So because oil stocks’ profits are determined
by oil prices, and profits ultimately drive stock prices, oil drives
oil-stock levels. And this
Relative Crude Oil chart clearly shows that oil was hammered to prices that
were as oversold as it has seen since emerging out of the stock panic in
early 2009. With oil due for a
major new upleg soon for its own technical and
sentimental reasons, this is very
bullish for oil stocks.
The flagship oil-stock index is now called the NYSE Arca Oil Index, but is better known by its classic symbol
XOI. It was established 27 years
ago and includes 13 major oil stocks with a mammoth collective market
capitalization of $1603b at the end of July before the lion’s share of
the recent sharp correction.
While the gigantic XOI components are much slower to move than the
smaller higher-potential oil stocks we prefer to trade, it is still
representative of this sector as a whole.
Like the valuable and scarce commodity they bring to
market, oil stocks have experienced two major uplegs
and two major corrections in this post-panic era. This latest correction was huge by oil-stock standards,
the XOI surrendered 29.1% in just 5.2 months. This selloff was so darned severe that
it hammered oil stocks back down to price levels seen in mid-2009 when oil
was trading around $60!
To give you an idea of how goofy this is
fundamentally, in August and September 2011 during the recent stock-market
bottoming process oil prices averaged $86 which was over 43% higher! And they never fell much below $77 at worst, fully 28% higher. Excessive fear drove the oil stocks to
totally-irrational price levels far disconnected from their underlying
fundamental reality. The XOI was
beaten back to a super-low major-support line formed during this
index’s last correction in the summer of 2010.
In Relativity terms, the 5-calendar-year horizontal
trading range of the rXOI now runs from 0.95x to 1.20x.
The XOI tended to be oversold near 95% of its 200dma and overbought
near 120%. This latest XOI
correction was so massive that it pummeled the rXOI
down to 0.789x early last week!
Just like oil, oil stocks were as oversold as they’ve been since
right after emerging out of the secondary stock-panic lows in early 2009!
After the XOI’s last correction in summer 2010
which pushed oil stocks to far-less-oversold levels than seen recently, this
flagship oil-stock index still powered 59.5% higher over the next 10 months
or so. We bought smaller oil
stocks aggressively during summer 2010’s oversold conditions,
and many of our trades more than
doubled by early 2011. After
oversold conditions in secular bull markets, major uplegs are born. And the more oversold prices get, the more potential the resulting buying opportunity
has.
With both oil and oil stocks as oversold as
we’ve seen since just after that epic once-in-a-century
stock panic, today’s buying op is amazing. With oil demand relentlessly growing
globally as most of the world continues to industrialize, and large new
oilfields ever-harder to find, oil stocks ought to bounce back rapidly from
their deeply-oversold levels to reflect oil’s bullish fundamental
reality. The brave contrarians
who can steel themselves to buy low in this uncertainty are going to win huge
gains.
Oil and oil stocks weren’t just crushed in
massive corrections because anything fundamental changed, but simply because
excitable traders got scared. The second correction of
the stock markets’ post-panic cyclical bull plunged precipitously after
Obama’s profligacy triggered the first USA debt downgrade in history in
early August. Commodities stocks
got hammered with general stocks, but many commodities including oil remained
relativity resilient at that time despite the stock selling.
But then in early September as the stock markets
were bottoming, a terrible monthly US jobs report was released showing zero jobs created. This led economists to assume the US
was plunging into a new recession.
These mushrooming recession fears weighed on commodities and
commodities stocks all last month, and were greatly exacerbated when the
Federal Reserve failed to announce a third round of quantitative easing as
some traders had hoped.
Commodities and their producers’ stocks just plummeted.
But not surprisingly, traders were far more scared
than economic reality warranted.
Hyper-oversold conditions in the stock markets and commodities (which
I discussed last week) led them to
assume the sky was falling. They
feared that Greece is doomed, Europe is fracturing, China is slowing, and the
US is facing a recession. But
weak markets always make traders,
economists, and analysts very pessimistic and bearish. They start expecting the worst at
exactly the wrong time, after the bottoming is underway.
Ironically, the jobs report that initially ignited
all the recession fears was just revised way
higher by the US Labor Department.
Last Friday it said that August jobs growth wasn’t really zero
as originally reported, but much better
than the expectations at the time (+57k). So the fountainhead of the recession
fears was retroactively revised upwards, leading economists to double the US economic-growth
forecasts that they had halved on that original bad jobs report.
The deeply-oversold levels in oil and oil stocks
we’ve seen in recent weeks were an
anomaly driven by excessive pessimism and bad data that no longer
exists. As always after major
corrections, fear got out of hand.
It so blinded the majority of traders that they started pricing in an
apocalyptic slowdown in the global economy that was never in the cards. And oil and oil stocks got trapped in
this fear crossfire.
Considering how terrified traders became over the
worldwide economic prospects, it was actually pretty impressive how high oil
prices remained. And if oil
demand stayed high enough so oil could trade between $80 and $90 when the
markets were trying to price in a new
panic, imagine how high oil will surge as those economic fears inevitably
fade. The potential gains in oil
and oil stocks are enormous.
At Zeal we’ve been aggressively buying oil
stocks throughout this fear-laden bottoming process. It is never easy fighting the crowd,
adding new trades when everyone else is scared. But during such ugly oversold
conditions is the ideal time to buy low, a necessary prerequisite to selling
high later. We did this during
the last oil and XOI correction in the summer of 2010 too, and were richly
rewarded with huge realized profits just 6 to 9 months later. But which stocks to buy?
We just finished a 4-month deep-research project
investigating the entire universe of mid-cap oil stocks trading in the US and
Canada. We gradually whittled
this list down to our dozen favorites fundamentally, which are profiled in
depth in a fascinating new 36-page report. These
elite mid-cap oil stocks have amazing fundamental prospects, and are trading
at oversold levels like their larger peers. For just $95 ($75 for subscribers),
you can enjoy the profitable fruits of hundreds of hours of expert
world-class research. Buy your report today and get
deployed in cheap oil stocks!
We also publish acclaimed weekly and monthly subscription
newsletters. In them I draw on
our vast experience, knowledge, wisdom, and ongoing research to explain what
the markets are doing, why, and how to trade them with specific stock trades
as opportunities arise. Our
contrarian trading, buying when others are scared and selling when others are
greedy, has been wildly successful.
Since 2001, all 591 stock trades
recommended in our newsletters have averaged annualized realized gains of
+51%! Subscribe today and
start thriving!
The bottom line is oil stocks were just driven to
deeply-oversold levels. Excessive
fear spawned by a healthy-yet-sharp stock-market correction, combined with
since-revised-away economic data, convinced traders a new global recession
was brewing. So they rushed to
dump oil and oil stocks, driving each to their most oversold levels seen
since early 2009 as they emerged out of the secondary stock-panic lows.
But oversold levels never persist for long in an
ongoing secular bull. As the
irrational fear that spawns them inevitably passes and fades, oil and oil
stocks will be bid back up to prices reflecting today’s bullish
fundamental reality for this crucial commodity. Contrarian traders who steel
themselves to fight the herd and buy low when everyone else is scared are
going to enjoy huge oil-stock profits in the months ahead.
Adam Hamilton,
CPA
Zealllc.com
So how can you
profit from this information? We publish an acclaimed monthly
newsletter, Zeal Intelligence,
that details exactly what we are doing in terms of actual stock and options
trading based on all the lessons we have learned in our market
research. Please consider joining us each month for tactical trading
details and more in our premium Zeal Intelligence service at … www.zealllc.com/subscribe.htm
Questions for
Adam? I would be more than happy to address them through my
private consulting business. Please visit www.zealllc.com/adam.htm for
more information.
Thoughts,
comments, or flames? Fire away at zelotes@zealllc.com.
Due to my staggering and perpetually increasing e-mail load, I regret that I
am not able to respond to comments personally. I will read all messages
though and really appreciate your feedback!
Copyright 2000
- 2006 Zeal Research (www.ZealLLC.com)
|
