One of the things that appeals to me about energy investing is that very often, the energy sector’s sensitivity to changes in demand makes it a kind of “canary in the coal mine” for the broader stock market. That is only useful, however, when energy, or more specifically crude, is leading the way. What we have seen over the last few months, and increasingly over the last couple of weeks, is the opposite…stocks are leading crude prices.
I don’t mean that the two are moving in absolute lockstep every day, but rather that the overall sentiment that is driving WTI futures seems to be one borrowed from stock traders, namely that even though the U.S. economy is in tatters, everything will be fine really soon. That has shown itself of late, not in the form of a big pop in crude, but in CL trading in a rapidly narrowing range, even in the face of very bearish news.
Within the U.S., it is clear that the rapid reopening by some states of their economies was a huge mistake. Coronavirus cases in places like Florida, Arizona and many other Southern and Western states that went that route are exploding, pushing the overall rate of new cases in the U.S. to new highs seemingly every day. That leaves the Governors with an unenviable choice of either admitting they were wrong or risking the lives of thousands of their constituents to avoid doing so.
I can be as cynical as the next person when it comes to politicians, but not even I think…
One of the things that appeals to me about energy investing is that very often, the energy sector’s sensitivity to changes in demand makes it a kind of “canary in the coal mine” for the broader stock market. That is only useful, however, when energy, or more specifically crude, is leading the way. What we have seen over the last few months, and increasingly over the last couple of weeks, is the opposite…stocks are leading crude prices.
I don’t mean that the two are moving in absolute lockstep every day, but rather that the overall sentiment that is driving WTI futures seems to be one borrowed from stock traders, namely that even though the U.S. economy is in tatters, everything will be fine really soon. That has shown itself of late, not in the form of a big pop in crude, but in CL trading in a rapidly narrowing range, even in the face of very bearish news.
Within the U.S., it is clear that the rapid reopening by some states of their economies was a huge mistake. Coronavirus cases in places like Florida, Arizona and many other Southern and Western states that went that route are exploding, pushing the overall rate of new cases in the U.S. to new highs seemingly every day. That leaves the Governors with an unenviable choice of either admitting they were wrong or risking the lives of thousands of their constituents to avoid doing so.
I can be as cynical as the next person when it comes to politicians, but not even I think the most likely outcome there is a massive human sacrifice on the altar of politicians’ pride.
So, as encouraging as the news regarding gas consumption has been over the last few weeks, there is a distinct possibility that more forced shutdowns will nip the recovery in the bud. Add to that this week's big energy news, that OPEC+ is going to gradually unwind their production cuts, leading to OPEC members resuming exports, and crude holding above $40 doesn’t make a lot of sense.
Unless, of course, it is simply following the lead of stocks, where the S&P 500 is higher than a year ago. That is despite double-digit unemployment, a drop in GDP, and earnings that are, according to FactSet, expected to decline 44.6% from the same quarter last year.
If that makes no sense to you, I can assure you that you are not alone. It is obviously completely illogical, but as I often say, traders must deal with what is, not what they think should be. Obviously, both the stock market and the oil market are overdue a downward correction but that doesn’t mean that is coming any day.
The point is that all the bad news for oil prices, and for stocks, is already out there, and yet, here we are, flying relatively high. A positive result from an initial vaccine trial by Moderna (MRNA) this week, for example, sent both stocks and oil higher, even though it was from an extremely limited phase one study. Based on history, that makes it probable that even if that is replicated, we are many months, maybe even a year or so, from mass production of a vaccine. Good news is being exaggerated and bad news ignored and as long as that continues, a big move down looks unlikely.
If anything, in the short term, the more I look at that chart above, the more bullish it appears to me. The range is narrowing due to a steep upward slope of the bottom trend line, indicating a breakout to the upside is imminent. So, it is the classic traders’ dilemma. The technical and short-term picture is suggesting a move in the opposite direction to that indicated by fundamental conditions. That could even continue until the reality of those fundamentals catch up to the optimism of the markets, so what is a poor trader to do?
My answer is to trade with the bullish bias that the chart suggests, but to do so in a way that reflects my lack of long-term confidence in that trade. That means that both my stops and target prices will be narrower than usual, and I will always be on the lookout for the beginnings of a sustained drop such as a multiple top in either oil or stocks, or three successive lower closes.
That isn’t an ideal situation to be in, but it is what the market is giving me right now, so I have little choice. If the move down does come, then it is likely to be sustained and the strategy would change to momentum trading with the exact opposite tactics, wider parameters to allow for small corrections but stay short as the trend develops.
For now, though, the only logical thing to do is the illogical trade.
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