Our longtime readers know that we’ve been bullish on oil for more than two years, dating back to April 2016. A month ago, we told you here that oil was set to move much higher. It had just crossed $70/barrel and many commodity analysts and traders were looking for $80/barrel in a short period of time.
Why were oil prices poised to increase so quickly? The OPEC nations were talking about cutting back on production, the Iran Nuclear Deal was scuttled, and Venezuela’s production was cut drastically.
So what happened over the past couple of weeks? The price of oil dropped by 10%, moving from above $72 down to $65 in a short period of time.
Does this price drop change our outlook? Not at all.
Oil’s Volatility Quotient (VQ) is 29.1%. A price drop of 10% is well within its range of normal volatility. Even at this price, we’re still $6 away from touching the top of the Stock State Indicator (SSI) Yellow Zone. And we’re $15 away from hitting the SSI Stop signal.
The price of oil could move lower over the next few months. Our proprietary time-cycle forecast shows that pressure to the downside could continue into August or September.
By the way, when looking at time-cycle forecasts, the direction is the most important element of the chart, not the amplitude. We do not believe that oil is heading below $30 in the next few months, but the likely direction is to the downside.
Though oil prices have dropped and look like they will continue to move lower, the price of the oil and gas companies hasn’t changed much.
Four weeks ago, we highlighted XOP, the S&P Oil and Gas Exploration and Production ETF. Unlike XLE, the SPDR Energy Sector ETF that is market-cap weighted, XOP takes a modified equal-weight approach. The smaller companies have the same effect on the ETF as the larger companies.
XOP has a VQ of 28.2%, which is just slightly lower than the VQ for oil itself. But even though its volatility is almost the same as oil, the price of XOP has dropped less than five percent during this same period of time.
Why has oil dropped, but the oil and gas companies barely moved? The domestic oil and gas companies are in good shape financially, and with the current oil prices, these companies can be very profitable.
A month ago, the top 10 holdings of XOP had seven stocks in the SSI Green Zone and three stocks in the SSI Red Zone. Today, even though the price of oil has dropped, eight of the stocks are now in the SSI Green Zone, as QEP Resources (QEP) triggered an SSI Entry signal three weeks ago.
Bottom line: Nothing has happened to change our opinion on oil and the oil companies. XOP has a long way to go before it reaches its all-time high of $79.80 that was set in June 2014, and it’s heading in the right direction.
XOP is a little cheaper right now, so if you didn’t get in earlier, now could be a good time if it fits into your portfolio. And if oil does move lower over the summer and into the fall, the prices for the oil companies could also move lower, creating even better entry opportunities.
The U.S. oil companies look to be the beneficiaries of the long-term bull market in oil … and XOP looks to be a good way to gain exposure to this sector.
Have a great weekend.
Richard Smith, PhD
CEO & Founder, TradeSmith