Focus on the Leaders

From the Desk of Ian Culley @IanCulley

We’ve been loud about energy lately. And how can we not be?

Energy stocks were the most resilient during the H1 selloff and are by far the best-performing sector off the 2020 lows. Every afternoon, energy quietly leads the pack into the close, whether the market is green or red on the day.

But the recent rally in stocks has started to fizzle. And even energy is beginning to feel the downside pressure.

While everyone scrambles to label the recent rally, gearing up for the next leg higher, or preparing for the world's end, we want to focus on the leaders – energy!

If this leadership group starts to fall, it could be an early warning sign of broad selling on the horizon.

And, with Labor Day upon us, it just so happens the energy sector ETF $XLE is retesting a critical shelf of former highs.

Here’s a chart of XLE:

Like many cyclical areas of the market, XLE reclaimed its prior-cycle highs during the recent rally. It’s only two weeks, and energy stocks are already retesting that critical level. That raises the following question:

Are we witnessing a classic throwback within an ongoing uptrend? 

Or is another bout of broad selling pressure just around the corner?

One thing is certain: Energy and stock market bulls want to see XLE hold above its former 2018 highs of 78.

But if energy stocks are going to catch a sustained bid, their associated commodities can’t continue to print fresh lows.

When we look at a triple-pane chart of crude oil and its derivatives (heating oil and gasoline), we’re not seeing constructive action:

Heating oil remains buoyant, while crude oil and gasoline churn below overhead supply.

It’s messy for these commodities as it is for most areas of the market.  Regardless, we don’t want to make the bet crude and its derivatives will resolve in opposite directions. 

If crude and gasoline don’t catch higher toward heating oil soon, it’s only a matter of time until the latter breaks its pivot lows. XLE most likely follows to the downside.

But what about all the big bases in energy names?

Well, they’re probably not breaking out in that scenario. The market is tough right now. So you have to understand the energy trade carries a big caveat… 

Their associated commodities can’t roll over. 

It’s hard to imagine upside resolutions in oil and gas names while crude hits new year-to-date lows.

And if the bulls lose control of the most resilient group of stocks, what would that imply for the broader market?

It wouldn’t be bullish.

Of course, we haven’t seen a decisive move in either direction. That’s why it’s essential to focus on the leaders, including their associated commodities.

How these assets perform in the coming weeks will provide critical information regarding the overall health of the market.

Stay tuned!

COT Heatmap Highlights

• Commercial hedgers continue to hold within 3% of their largest long exposure to crude oil in three years.
• Commercials carry one of their largest long position in platinum since risk assets peaked in 2018.
• And commercials are officially net long silver for the first time since the spring of 2019.

Click here to download the All Star Charts COT Heatmap.