Breaking Down the Energy Sector

• Posted by Alex
• on October 8th, 2012

Brilliant Technical Analyst and Trader Alex Tarhini breaks Energy down for us today. I think he does a terrific job:

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With crude oil making a quick retreat from its brief test of 100 dollars a barrel, it seems like a good time to check the pulse on the energy sector.

For the trailing 30 days, the scores chalk up to:

$SPY ~ 1.95%

$XLE ~ 1.00%

$USO ~ (5.50%)

$PSCE ~ (2.15%)

(using prices as of 10-5-2012)

Looking at the Energy Sector ETF ($XLE) for an overall view of the space, it has under-performed the market by about 1% for the last month, but it is still holding up. The 72.30-72.50 area is the logical area we expect support and is our current line in the sand. Holding above this level, it is hard to be dramatically bearish, but the under-performance and weakness in oil can’t be ignored.

After crude oil’s dramatic fail at 100.00 dollars a barrel, it has held lower in a methodical fashion. $USO has a logical line near 35.00, it was prior support and very close to the current 50 day moving average (MA). Oil continues to trade well below its 200 day MA, but is also at the lower end of its current range at ~32.50. This is a high risk area to be outright short crude but still a bearish check mark for the sector.

A note on crude oil: its correlation has changed dramatically over the course of this year. It has gone from a strong positive correlation, to a near zero correlation (to the S&P 500) when using a year’s worth of price data (white line below). This means that the typical “risk on / risk off” trade is not happening. Crude oil is moving on its own accord.

On the bright side,  MLPs continue to look great. While somewhat extended based on their RSI reading, they are breaking out of a 3 month consolidation, and have shown low volatility and resilience on market down days, a favorable trending quality.

Small cap energy names are at a critical point, gripping the 50 day MA as support and currently trading around the 200 day MA, implying a swift move away from this area is highly probable. They are  certainly lagging for the trailing month, down ~2.15%, not a very positive data point for the space. A hold (at least 2 closes) above 34.00 would be supportive for these small caps.

The oil service names ($OIH) had a false break out of sorts in September, and are currently sitting below their 50 day MA where they didn’t manage to bounce, a short term resistance level for us. Like crude oil, they are at the lower end of their range, not somewhere to be outright short if you don’t have a prior position, but another bearish point in the sector. A hold of the 39 area and regain of the 50 day would be very constructive.

The oil service names relative to the S&P 500. Bearish with some room to the downside.

Oil service relative to the energy sector, bearish but nearing an extreme at ~0.53.

In summary, oil’s current move has definitely impacted energy names and brought some under-performance to the sector. The lines are in the sand for us. We see enough data to stay objectively bearish the sector and assume continued under-performance until proven otherwise. This could be done by seeing oil and small cap names hold up their support areas during next week or so. MLPs are the shinning stars in energy and we will stay bullish that space as long as they hold their trend.  As for the sector’s impact on the broad markets, it should be minimal with oil having a near zero correlation to the S&P 500.

 

Make sure to follow Alex Tarhini on Stocktwits & Twitter @TarhiniTrade

Tags: $USO $OIH $SPY $CL_F $XLE

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