Energy Sector Reaching Exhaustion Point

Back in mid-December I wrote that the energy sector was approaching overbought. Since then it has added another 12% and reached the extremes that I suggested it was nearing. Since Rydex has two specialty sector funds I thought I would combine them to get a full picture of the retail excitement for this sector:

The energy sector has risen appx. 131% since the cyclical low in March 2009 with the majority of that arriving in a furious climb over the past few months. The total assets in the Rydex Energy Sector and Energy Services sector funds (aggregate) have almost quadrupled as retail investors have rushed in with more and more excitement to ride the momentum. And to follow up another analysis I mentioned with regards to the assets in the Rydex Energy ETF, its NAV has gone up an additional 6.6% since I wrote about it but the total assets have gone up an additional 17%.

Helping all of this is the fact that crude oil is getting a lot of bullish notice these days. We have the nice round target of $200 suggested by Jim Rogers. And we just had the revelation from WikiLeaks that Saudi Arabia’s reserve numbers are about as inflated as Kanye West’s ego – according to Sadad al-Husseini, the geologist and former head of exploration at the Saudi oil conglomerate, Aramco. The inflation of reserves by Saudi Arabia is something that we’ve been hearing about for several years now from different sources so it isn’t earth shattering news. But it is important to remember that major tops are formed with the help of positive news and major lows are carved out of misery and desolation.

To see what I mean, we don’t have to go any further than the “ultimate contrarian” call I made on BP a few months ago. At the time there were rumors swirling of the company’s demise, its liquidation, or at least, garnishments of its dividends to pay for the Mexican Gulf oil spill disaster.

Fast forward to today and BP’s stock (BP) has recovered more than 70%. Exxon Mobil (XOM) – the largest capitalization public stock in the world – is also back on top once again. Its shares have risen about 45% since their lows last summer. Being the bellweather for the sector, it is important to monitor how it is trading. The rise has taken the share price back up to prior resistance and the relative distance from its 200 day moving average is also stretched to the breaking point:

Historically, when XOM gets pushed up 20% or more above its long term trendline, it either pauses, entering into a consolidation pattern or it corrects and retraces those gains. Right now the stock is trading at 20% – after reaching a recent peak of 23% in early February 2011.

As well, we have to consider that sentiment towards crude oil is very elevated right now. All the stocks in the sector are trading above their 200 day moving average and 84% are trading above their 50 day moving average (and have been for some time). The CoT report shows retail future traders being crazy long while commercials are taking the other side – both at a multi-year extreme.

One caveat is that the bullish percent index for the energy sector is still not giving us an extreme reading. The current 80% is a tad short of the 90% that has historically accompanied major tops in the sector.

Sectors take turns being the stars of the bull market. According to research by Ned Davis, it is very rare to find a sector that gets a repeat performance. Since the start of the bull market, this sector – as measured by the Oil Services HOLDRs ETF (OIH) – has been among the best performing sector with a 140% return while the S&P 500 index has returned 100% (so far). No one knows what sector will come out ahead next but we do know that the probability that it will be energy related is very low.

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8 Responses to Energy Sector Reaching Exhaustion Point

  1. Tiho says:

    Sounds like you are calling a top on Energy here? And you are advising people that Energy will under-perform, because some guy from Ned Davis said so?

    When I look at Exxon Mobil, Chesapeake, Statoil, Petrobras, PetroChina or Rosneft – major Oil & Gas companies around the world – they all had an awful 2010 compared to the Equity Indices like S&P 500 or Emerging Markets. Exxon Mobil just recently tested its March 2009 low again. Did the S&P 500 do that?

    Relative strength compared to the indices was so bad until recently. These companies are cheap compared tot he whole index. Also look at the commodities themselves. Crude Oil and Natural Gas were some of the worst performers in the CRB Index last year. Crude Oil has under-performed Gold for almost three years and in my opinion is so cheap relative to Gold. And yet, you are now advising us to buy Gold and to sell Energy, just as Crude Oil broke out after consolidating for almost two years?

    However, I do agree that we are over stretched and overdue for a correction, but I wouldn’t scare people about the Energy sector the way you do. Energy always does the best at the end of the bull market, especially if it is a secular commodity bull. Just look at October 2007 when S&P 500 topped, while Energy sector kept moving up until May 2008.

  2. Babak says:

    Tiho, I’m just presenting some ideas based on my analysis of the facts. That includes sentiment, technical analysis and the positioning of the futures traders via CoT. What you or anyone else does with this information is up to each person.

    I’m agnostic when it comes to fundamentals like earnings or PE (except in very extreme cases). And I go where there are opportunities. Since I beat the table on gold last month it has already found its footing and rallied higher. Bonds? not so much 🙂 So clearly I don’t have a monopoly on the truth nor do I pretend to.

    To clarify, regarding sector leadership, I was pointing to research by NDR that shows that each bull market is propelled by one or two sectors and that these sectors are usually not the same for the next bull market.

    Oh and I just read this, which might also be interesting to those following this discussion.

  3. PEJ says:

    Tiho, Babak,
    I would definitely side with Babak on this one. I actually have two posts in the past couple days about the major top forming in oil. Given the situation in equities, I would be surprised that they both get hammered.
    Oil speculation far exceeds the levels reached in 2008
    Oil Speculation Reaches All Time Highs As Gasoline Supply Rises to 18-Year High
    Oh and Tiho, I’m actually using one of your charts in my post 🙂

  4. Pingback: Jim Chanos Happy With Short Position In China | tradersnarrative

  5. Tiho says:

    To study and not think is a waste. To think and not study is dangerous. ~ Confucius

  6. biscosc says:

    I’d rather see some numbers like average 3 to 12 month performance of these funds after reaching these peaks in assets rather than just the chart you show. People see what they want in those kind of charts. To me it looks like a short term correction followed by more gains or sideways action. I don’t see any big danger of falls in the next 3-12 months. The fact is you can catch fat right tails by riding these bubbles and that’s what I’m after.

  7. Machine Ghost says:

    > Crude Oil has under-performed Gold for almost three years and in my opinion is so
    > cheap relative to Gold.

    Fact: Right now gold vs crude is exactly historically neutral as a ratio, neither undervalued nor overvalued.

    You need to study and not think…

  8. Tiho says:

    Machine Ghost: you really need to think things through, instead of just looking at a ratio. If you really think about it, a bullish scenario with an economic recovery will bring about a stronger demand for Crude while production will not be able to keep up. IEA has now increased the demand forecast five months in the row. This is not some guy on the forum called Machine Ghost… This is the IEA! And demand and supply is what moves energy market. Not some Rydex sentiment indicator!

    And if you are bearish on the world, and see a deflationary bust occurring as QE 2 ends, than rest assured they will do QE 3, and 4 and so on, as they will run a trillion dollar deficits for ages and ages and ages, so printing money does not solve anything other than create a war. Study history and you will see that money printing creates turmoil.

    So think about it, in both case scenarios Oil will go up ALOT!

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