Reports from the Energy Patch
Two weeks ago, I decided to do a short- and long-term chart analysis on gold stocks for my Cabot Wealth Advisory—and the reader response was great. So today, I’m doing another Wealth Advisory featuring short- and long-term chart analysis, this time on oil stocks, which are at an intriguing stage following a brutal decline over the past couple of years, a quick recovery and recent softness as investors panic over all things Brexit.
So let’s dive right in. As always, my focus is on the stocks, not the commodity—if you’re going to buy the stocks, you want to study the action of the stocks, not something else. I’ll focus on the SPDR Oil Exploration Fund (symbol XOP), an ETF that owns a ton of oil stocks but isn’t as heavily weighted toward mega-cap names as some of the other oil ETFs. (XOP’s largest stock holding is just 3% or so of the fund, while other oil ETFs have 18% to 21% of their fund in their single largest holding.)
Even so, all the ETFs look very similar and the conclusions reached by analyzing any of them are the same.
Long-Term Trend is Turning Up … Short-Term?
Let’s look at the long-term picture first, starting with the weekly chart:
Here are a few key points:
From top to bottom, energy explorers fell a whopping 73% from July 2014 through January 2016 (18 months). That’s not as harsh or as long as the drop we saw in gold stocks, but it’s still plenty large and over a long enough period to conclude that all the weak hands were shaken out.
Second, notice the weekly volume surge in late-February and early March. While trading volume in ETFs isn’t as meaningful as it is in individual stocks, I think it’s safe to bet that a ton of big investors were getting in at this point, which also could indicate a meaningful bottom.
Third (on the more negative side), notice that while the XOP ETF has rallied nicely and has been “living” above its 40-week moving average, it’s still stuck below resistance near 40. Another yellow flag is that there wasn’t much of a bottom-building process—the fund simply sank to 22 in January and began rallying within a month or so.
So there are more positives than negatives on the chart. I am willing to say XOP has likely hit its bear market bottom … but I’m not as certain of that as I am with gold stocks. I would characterize the longer-term trend of oil stocks at this point as mostly neutral, though possibly turning up if XOP can lift above 40 or so in the weeks ahead.
Now let’s drill down to the short- to intermediate-term picture. Here’s the daily chart.
My first thought is that the intermediate-term trend is clearly up—until today, XOP has been trading above its rising 50-day line since mid-March. That’s about three full months of solid action—obviously a good thing.
But the group is at a critical juncture here. XOP has dipped below its 50-day line due to the market’s Brexit fears. A decisive break of the 32 area would be a bad sign, and could usher in a longer base-building process in the weeks ahead.
So what do I think in terms of buying and selling?
If you really want in, you could nibble on the XOP here with a tight stop near 33 (or just below). This could be a great entry point—the fund is down into an area of key support and you can cut investor uncertainty with a knife (especially concerning Brexit fears). Any relief from those uncertainties could cause a major rally.
Of course, there’s downside risk, too … but that’s why you’d cut any loss quickly.
But I’m more interested in individual oil stocks (the stocks that will outperform the sector average), and the good news about the 18-month wipeout and the ensuing recovery is that it’s made it easier to see which stocks in the broad energy patch are under real accumulation.
I’m looking for stocks near 12-month, or preferably, all-time highs, while avoiding the stocks that have only bounced weakly since February.
A New Leading Oil Stock for the Next Bull Move
To this point, it’s clear to me that explorers operating in the Permian Basin in Texas (and, more specifically, the Midland and Delaware Basins that sit within the Permian) are attracting big money. The reason: Even at current energy prices, the wells in the best areas are producing solid long-term returns, thanks to a combination of oil-rich wells, better-than-expected output levels and rapidly falling costs to drill and frack.
My favorite play in the Permian is a stock few investors have heard of, but it’s one of the few hitting new all-time highs. It’s called Parsley Energy (PE). Here’s what I wrote about it in Cabot Top Ten Trader a couple of months ago:
“Oil stocks are coming to life, and Parsley Energy seems a good bet to lead the charge. The company has all the characteristics of a big energy winner if oil prices cooperate. Parsley owns lucrative acreage in the Midland Basin in Texas, with its wells in its key Wolfcamp areas churning out 40%-plus returns even at $45 oil. (Its wells are also the top performers in the Midland, so it’s in the best spot within one of the best basins in the U.S.) Moreover, the firm has substantial oil hedges in place right through the first half of 2017 (oil makes up nearly two-thirds of the company’s output and even more of its revenues), which is allowing Parsley to continue with its rapid expansion plan. Production grew 55% in total last year, and should grow another 40% to 60% in 2016, with oil output growing even faster than that. And that’s with CapEx remaining flat! Looking ahead, if oil prices continue to recover, there’s years worth of growth ahead—Parsley has well over 1,000 drilling locations in the Wolfcamp areas alone, and it’s taking advantage of the poor environment to expand its footprint via acquisitions as opportunities arise. Earlier this month, for example, the company spent $359 million to add another 23,000 net acres, boosting its total acreage by 20%. And all of this says nothing about Parsley’s potential in the Delaware Basin (southwest of the core Midland), which has shown very promising results of late. We think Parsley will do very well in any sustained bull move in oil stocks.”
And PE has done well, trending steadily higher since late February, with just one test of its 50-day moving average during that time (early May), and it’s taken the recent selling in oil stocks and the general market in stride.
Should you buy it here? It’s a tough call given the market environment.
My take is to play it halfway—consider buying a half-sized position around here or on dips toward the 50-day line (i.e., if you usually buy $6,000 of a stock, buy $3,000 of PE), and use a relatively tight loss limit (10% or a bit less).
You could then look to buy more shares if/when the market shapes up and the stock shows you a profit of 10% or so.
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