From the Desk of Ian Culley @IanCulley
Investors hate commodities – especially energy.
I don’t blame them.
Most energy stocks and commodities have failed to provide the best opportunities for the average market participant.
In fact, they’ve been an absolute dumpster fire compared to high-flying tech names for almost a decade.
But everything changed following the 2020 sell-off.
Commodities flipped the script, outperforming bonds and stocks. Long-forgotten energy names worked their way back in the conversation as the energy sector taught a masterclass in relative strength.
This story isn’t finished – not yet!
One glance at the market’s year-to-date performance reveals an explosive tech rally that’s managed to erase the past two years from our collective memory.
That’s why I think it’s more important than ever to reiterate why I still like commodities in the back half of the year, specifically energy.
Here are five charts to prove my point…
1. Energy Contracts Take the Lead
Our EW Energy Commodity Index has gained almost 20% since May 4 (when the 10-year yield posted a key pivot low and gold futures peaked).
That’s more than twice the upside of other commodity groups.
Remember, we always want to buy the strongest and sell the weakest.
Right now, energy contracts exhibit the kind of strength we want to buy.
2. EW Energy Index Reclaims 2018 Peak
Not only is the EW Energy Index leading the commodity space, it’s also breaking back above its prior-cycle peak from 2018.
I’m sure you’ve heard the team refer to those key former highs in reference to global equities, as 2018 marked a significant top in global risk assets.
The same level applies to commodities.
Here’s energy posting a potential bull hook:
I can’t present a bearish energy thesis as long as these contracts are trading above their respective former highs.
Yes, it’s messy.
But my outlook has shifted from giving the energy the benefit of the doubt to identifying the best vehicles and strategies to profit from the next leg higher.
3. Healthy Demand for Crude Oil Distillates
All eyes were fixed on gasoline futures as inflation raged. That’s no longer true now that prices at the pump and headline inflation numbers are well off their 2022 highs.
Unlike the news cycle, I have not averted my gaze as I monitor these markets daily.
And I’ve noticed gasoline futures quietly carving out a potential inverted head-and-shoulder pattern:
I view the constructive basing formation as a bullish data point on its own, indicating healthy demand.
Nevertheless, an upside resolution in gasoline futures would verify my bias.
If and when it occurs, I’m tracking the 14-day RSI for an overbought reading for confirmation.
4. Energy $XLE vs. Tech $XLK
Energy versus tech may be the most important intermarket relationship during the second half.
The energy sector finds itself at a logical level of support against technology stocks, highlighted by a key retracement level and shelf of former highs.
Will energy dig in and resolve higher?
If it does, the rising-rate environment persists, and cyclical assets will benefit the most.
On the flip side, it’s back to business as usual with tech and disinflation at the helm if the XLE/XLK ratio continues to fall.
I’m leaning toward energy over tech (big surprise).
But I will be quick to update my view with the data. That includes the XLE/XLK ratio resuming its downtrend.
5. Currencies Lead the Way… Higher
Our Petro-currency index is running back to its 2022 highs.
Will crude oil follow?
Check out the overlay chart of our petrocurrency index and crude oil futures:
I highlighted the widening divergence between these charts in early June, suggesting readers give crude and energy the benefit of the doubt.
Crude oil futures have rallied more than 10% since. And forex markets continue to lead black gold higher.
Buying tech stocks might feel like a slam dunk right now. We can simply ignore energy’s relative and absolute strength in favor of trading the markets from the past decade.
But investing and trading isn’t always about taking the easier or more comfortable route. In fact, my best trades have been the hardest to buy. I don’t think that’s a coincidence.
Perhaps energy will end up back in the waste bin. But based on the weight of the evidence, it’s not an outcome I’m willing to bet on – at least not yet.
COT Heatmap Highlights
- Commercial hedgers continue to hold a record-long position in Palladium.
- Commercials dropped more than 50,000 contracts of their net-long position for the US 10-year T-Note.
- And commercials are unwinding their long Corn position, lightening their load by more than 15,000 contracts.