You Need to Protect Against What's Coming With Oil

I told you last week that I'm bearish oil. 

That piece was a fundamental analysis of the situation that uniquely impacts the price of this commodity. 

When Tesla sees demand drop, it has to lower the price of its cars to incentivize purchases. 

When oil sees demand drop, OPEC+ cuts supply. 

Fundamentally speaking, you cannot trust the price of oil at face value. 

But that's not the only reason I'm bearish on oil. 

This time I'm pulling from my vast technical reservoir to show you that not only could May be rocky, but a lot of traders are going to be fooled into expecting positive results. 

 The below chart is an illustration of the performance of the United States Oil ETF (USO) by month from 2006 to 2023. 

So, as you can see, the month of May is a little bit funky. 

Do you mean to tell me that we finished in the red 59% of the time in May, but we're still net positive? Whenever I see data like that, I have to dig further and understand. 

That type of split between net value and frequency tells me that there is some serious volatility in the month of May. 

Not just that, it tells me there are some extraordinary performances to the upside that are throwing this out of whack. 

Naturally, I dug a little deeper to see if I could make sense of it... 

Let's take a look at the historical performance of the Energy Select Sector SPDR Fund (XLE) to see if we can get a clearer picture behind this volatility: 

And the key here is something I can only assume Malcolm Gladwell has tattooed across his chest "No Ragrets" style. Outliers. 

  1. 2009. 2003.

These are the three years where the XLE saw the biggest monthly gain in May in the past twenty years. 

Last year, the war in Ukraine sent the market into turmoil, and the cost of anything energy-related skyrocketing. It should come as no shock to see that the XLE shot up 16% in May as the reality of that conflict continued to sink in. 

We're not done yet. 

Back in 2009, we were emerging from the Great Recession. Of course, during a recession, the demand for oil is going to see a drop. Well, on the back of one of the biggest in history, we saw a 12.9% bump in May 2009. 

In total, 2009 was the best year for the stock markets since... 

You guessed it, 2003 - our final outlier in this equation. 

Similar to 2009, that year saw the market recover from the ill effects of the Dot-com bubble. 

What do all of those years have in common (other than the double-digit bump to XLE, of course)? They all feature serious macroeconomic factors that will not be in play when May 2023 kicks off. 

In fact, when you remove the performance of those three outliers altogether, suddenly that 59% negative performance starts to crystallize. 

Without 2022, 2009 and 2003, the XLE has returned -1.1% in total the past two decades. That's a swing of 2.4% from three years alone, putting us firmly in the red. 

A 41% win-loss percentage is something that should be in the red. Without the outliers, it is. 

As we enter May, at best, I'm neutral on oil. The reality is, I'm probably more bearish. 

Now, if we were coming out of a recession like we were in 2009 and 2003, well, things would be a lot different. 

But we're still on our way into one, no matter how hard the market tries to pretend that we're not. As a result, there is going to be more fundamental pressure on oil. 

There are a couple of things that are going to give me pause from being full-on bear mode, and one of them has nothing to do with technicals. 

We've seen time and time again that the hope trade is still persisting in this current market, so we can't discount the possibility of irrational traders impacting the market. 

On top of that, as we discussed at the beginning of this piece, oil is unique due to the role that OPEC+ plays in manipulating its price. 

So, while I can't do anything about the hope trade side of this, I can insulate myself from the OPEC+ side. 

As I mentioned in the piece on Friday, there is a key difference between the XLE and the iShares Core MSCI EAFE IMI Index ETF (XES). 

The XLE features companies like Exxon Mobile Corp (XOM) and Occidental Petroleum Corporation (OXY), whose bottom lines are directly impacted by the price of oil, which can be manipulated. 

But the XES features companies that are servicing the oil fields. Therefore, their bottom line isn't a product of the price of oil, but rather the number of oil drills running. 

And as I mentioned last week, XES has been falling apart all year. 

So, if I'm looking to short oil, I'm looking at the XES, not the XLE. 

My initial short-term target is a nice, round number - $70. If it breaks through that, I fully expect it to go as far down as $68. 

And I'll reiterate that Baker Hughes Co (BKR) is one company in the XES that I see having troubles ahead. 

This oil-field service company is trading around $30 right now. I'm looking at a four-to-six-week outlook for it to hit $26. 

But I wouldn't just go shorting every single oil-field services company outright. Not right now, at least.  

Of course, where there's trouble, there's also opportunity. 

When oil hits $70, there will be a lot of oil behemoths - like the aforementioned XOM and OXY - looking to scoop up smaller ones to cut costs and increase efficiency. 

Well, Wednesday night at 8 p.m., you can learn which five have the best chance at getting acquired. 

Not only that, you'll learn how to position yourself beforehand - and just how much money you stand to make as a result. 

Click here to make sure you don't miss out. 

The post You Need to Protect Against What's Coming With Oil appeared first on Penny Hawk.

About the Author

Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.

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