Energy Sector Update: In The Danger Zone

Last month I featured a chart showing the enthusiasm from Rydex traders for the energy sector and suggested that from a contrarian viewpoint, this was a bearish sign. Since then the sector has gone on to tack on another 6% – as measured by the Energy Select Sector SPDR ETF (XLE).

So was I wrong?

Clearly the sentiment indicator that I mentioned failed to pinpoint the top. But I’m still not convinced that this isn’t a high risk area for this sector.

The first reason is that the general market continues to hover in an overbought zone. As well, when we zoom in, within the energy sector there is too much enthusiasm. For example, just a few days ago Jim Rogers suggested in an interview with the BBC that crude oil was on its way to $200 a barrel. This is reminiscent of the Goldman Sachs’ $150-200 oil call that marked the previous cycle high.

Turning to the indicator discussed before, the total assets for the Rydex Energy Services sector fund have continued to remain elevated since mid-December 2010. Also, the Rydex Energy sector fund had a sudden inflow of $40+ million late last week. Clearly an institutional investor moved around their asset allocation.

Since ETFs are starting to encroach on the popularity of mutual funds, I also decided to look at the Rydex S&P Equal Weight Energy ETF. Below, you can see a chart of the total assets of this ETF compared to its NAV:

We only have a few years’ worth of data but even so, it is clear that a torrent of money is pouring into this sector from those chasing hot returns. After all, since bottoming in July 2010, this sector has risen 44%. Not too shabby – that’s almost double what the S&P 500 index returned. But to expect it to continue to outperform is a tall order.

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5 Responses to Energy Sector Update: In The Danger Zone

  1. Pingback: Wednesday links: adverse material changes Abnormal Returns

  2. Tiho says:

    Haha! Jim Rogers said Crude Oil “might” go towards $200 within the “next decade” – not tomorrow.

    • Babak says:

      True, but it is the target that is important. That big round number. It was the same thing for the previous Goldman Sachs $150-200 call. It wasn’t a call for tomorrow, but a future target.

  3. mark says:

    love your work…contrarian analysis at its best…keep it up!

  4. Pingback: Energy Sector Reaching Exhaustion Point | tradersnarrative

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