Thackray Market Note
Time to get Energized - Energy Sector Seasonal Strong Period from Feb 25th to May 9th!
February 25, 2016

 

I am not calling the oil bottom….but the seasonal period for the energy sector starts on February 25th and lasts until May 9th.

Currently, market pundits' predictions for the price of oil are all over the map.  Some are calling for oil to hit $20 a barrel and others $50. No one really knows because the variables that can change the price of oil are largely unpredictable.  Yes, an algorithm can be created to predict the price of oil based upon the current output, rig counts etc., but it is not possible to plug in a variable in the equation for “geopolitical speak,” such as Saudi Arabia releasing conflicting statements on possible future output within a week of each other.

The difficulty of predicting the trend in oil prices does not mean that an investment should not be made into the energy sector. There is nothing wrong with waiting for the sector to stabilize before taking a position, but there is a drawback to this approach: by the time the sector shows stabilizing tendencies, the sector could have already moved up 50% from the bottom. And of course, there is also the risk that just as you think the sector has stabilized, the rally proves to be a dead cat bounce and it resumes its decline once again.

­A different approach to entering the energy sector is to use a combination of technical and seasonal analysis. Seasonal trend analysis helps to determine the best general time to enter the sector based upon historical trends and technical analysis helps to fine tune this decision.

The energy sector has a strong seasonal period from February 25th to May 9th. In this time period, from 1984 to 2015, the NYSE Arca Oil Index (XOI) has produced an average return of 7.1% and has been positive 84% of the time. The sector has also outperformed the S&P 500® 78% of the time during the same period (see Thackray’s 2016 Investor’s Guide, page 25 for more information).  The chart below (from Thackray’s 2016 Investor’s Guide) illustrates the strength of the XOI trade (top graph) and the relative strength of the trade compared to the S&P 500® (bottom graph).

Oil tends to increase in price in late February due to changes in supply and demand structures.  A lot of refineries tend to shut down at this time of the year for maintenance and in addition, switch from winter gas to summer gas.  An increased demand for oil tends to occur in the spring as refineries have to pull a lot of oil through the system in order to make up for their maintenance schedules and gasoline switch and also to produce an increased amount of gasoline for the summer driving season that kicks off in May. Investors typically try to get ahead of this trade by investing in the energy sector in late winter and into early spring.



Technically, oil has been showing some strength recently as West Texas Intermediate has just broken above a down trend line, which is a bullish condition. Currently, there is resistance at $35. If West Texas Intermediate is able to break above this level, a $40 price is possible.



The positive trend in oil prices is showing up in oil stocks. The Energy Sector SPDR ETF (XLE) that trades on NYSE has been producing a bullish pattern of rising bottoms. Resistance lies just ahead at $58.50. A move above this level would be bullish. In addition, XLE is starting to break out of its downward trend line, which is also bullish.



It seems that most stock market commentators are negative on the price of oil, pointing to oversupply problems.  There is a general belief that the oversupply problem has to be fixed before an investment can be made into the energy sector. Intuitively, this sounds correct, but in reality it is not. The current price of oil already incorporates the expectations of the future, including the oversupply situation.  The current oil oversupply situation of approximately 1.0 to 1.5 mm bpd will not miraculously disappear overnight. It is not that strong positive news is needed to drive the price of oil higher….all that is needed is less negative news than expected.­ The strong seasonal period for oil provides a positive backdrop for less negative news than expected and even positive news.