ENERGY SHARES START TO SHOW RELATIVE STRENGTH -- GASOLINE AND HEATING OIL HAVE ALREADY BROKEN OUT -- HOW TO CHART FUTURES CONTRACTS FOR ENERGY SIGNALS -- WHY THE USO ALWAYS LAGS BEHIND PRICE OF CRUDE
ENERGY SHARES START TO SHOW RELATIVE STRENGTH ... Energy shares were this week's strongest market sector. That's the first time we've seen relative strength by the energy sector in three months. Chart 1 shows the Energy Sector SPDR (XLE) trading at the highest level in seven months. [A "golden cross" has also been formed by the 50-day average rising above the 200-day (gold circle)]. The line along the bottom is the XLE/SPX ratio, and shows it breaking a three-month down trendline. That's a sign that money is starting to move into this sector more aggressively. Chart 2 shows the Market Vectors Oil Services ETF (OIH) very close to breaking through its 200-day average (red circle). Its relative strength ratio (below chart) is also starting to rise.
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Chart 1
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Chart 2
RELATIVE STRENGTH MATTERS... In my view, "relative" strength is almost as important as "absolute" strength. But it's always better to show both rising at the same time. Relative strength signals, however, are often more valuable in signalling sector rotations into a stock sector. The black bars in Chart 3 plot the Energy SPDR (XLE) over the last three years. The gray area shows the XLE/SPX ratio. That ratio shows us what the sector is doing relative to the S&P 500. During September of 2010, the XLE/SPX ratio broke a yearlong down trendline (see up arrow) which signaled an upturn in the energy sector. Although the XLE turned up at the same same, the more impressive buy signal was given by the ratio line. That's why it's a good idea to supplement chart analysis with relative strength performance. And why this week's ratio upturn is worth noting.
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Chart 3
BE SURE TO KEEP AN EYE ON FUTURES CONTRACTS... When tracking the energy sector, it's important to chart all products which include crude oil, gasoline, and heating oil (as well as natural gas). The simplest way to do that is to plot their various ETFs. Chart 4 shows the United States Gasoline Fund (UGA) trading at the highest level in nine months. Chart 5 shows the United States Heating Oil Fund (UHN) testing resistance along its fourth quarter highs. An even better way to track the energy products is to chart their futures prices. Stockcharts recently added futures contracts to its listings. [You can view the futures menu by clicking the ^ feature on your keypad (upper case 6)]. The gray matter below Chart 4 shows the April 2012 Gasoline futures contract (^RBJ12), while Chart 5 plots the March 2012 Heating Oil Futures Contract (^HOH12). As you can see, the futures price generally trends in the same direction as their ETFs. In many case, however, the futures prices turn up first. The March Heating Oil contract below Chart 5 has already broken a yearlong down trendline and has reached a seven-month high. That upside breakout by the futures contract increases the odds for a similar breakout in the heating oil ETF. The reason I chose both of those futures contract is because they have the highest "open interest" which marks the dominant trading month. In order to get the most accurate picture of a futures markets, it's recommended that you plot the futures contract (month) with the highest open interest. [You can find that information in any newspaper that plots futures prices].
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Chart 4
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Chart 5
YOU CAN ALSO PLOT THE COMMODITY SPOT PRICE... Another way to plot the trend of a commodity is to chart its "spot" price. In the case of oil, that's the Light Crude Oil Spot Price ($WTIC) which is plotted in Chart 6. The spot price for crude oil is the price of the futures contract with the biggest open interest which, at the present time, is the April contract (^CLJ12). You can see that the spot price has already broken through its recent highs to reach the highest level in nine months. That's one of the advantages of charting the futures market which usually rises faster than the Oil ETF (USO). The fact that the futures contract has already broken out to the upside increases the odds for a similar upside breakout in the USO which is still testing resistance (see Chart 7).
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Chart 6
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Chart 7
WHY CRUDE OIL RISES FASTER THAN USO... Have you ever wondered why the United States Oil ETF (USO) lags so far behind the price of crude? In case you hadn't noticed, take a look at Chart 9. The gray matter shows the price of the crude oil spot price compared to the Crude Oil ETF (black line). It's obvious that the futures price of crude has risen much more than its ETF over the last three years. The reason for that has to do with the way the USO is structured and "contango". Contango describes a futures market where distant contracts trade at increasingly higher prices than the nearby month which is the case with crude oil. The April 2012 futures price of crude closed on Friday at 104.20, the July contract at 105.43, and the December contract at 105.69. The USO ETF owns the nearest futures contract which currently trades at a discount. It has to keep "rolling" that cheaper month into a higher priced one in the oil market which costs it some profit. As a result, the USO usually lags behind the futures price of crude. That doesn't mean that you shouldn't trade USO. But it's another reason to chart the futures market to get a better idea of where the USO is heading.
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Chart 8
DON'T FORGET NATURAL GAS... Natural gas has been by far the weakest part of the energy sector. Chart 9 shows, however, that a late week bounce by the United States Natural Gas Fund (UNG) left the price at the highest level in a month after staying above its January low. Its 14-day RSI line has risen to the highest level in nearly four months. That suggests that the natural gas downtrend has been contained, at least for the time being. The weekly bars in Chart 10 show the Natural Gas Spot Price trying to find support near its previous low formed during the summer of 2009. Its 14-week RSI llne dipped into oversold territory (below 30) for the first time in three years. That combination suggests that the price of natural gas is due for a bounce. A lot of energy stocks are tied to the price of natural gas, and stand to benefit from any signs of buying in that commodity. In fact, the two top stock performers in the energy sector this week are natural gas producers.
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Chart 9
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Chart 10
DEVON AND CHESAPEAKE ENERGY LEAD ENERGY SECTOR HIGHER... Devon and Chesapeake Energy were the two top percentage gainers in the energy sector this week. Chart 11 shows Devon Energy (DVN) surging above its 200-day average in very heavy trading. The ratio below Chart 11 compares DVN to the Energy SPDR (DVN:XLE). This week's upside spike is the first sign of energy leadership by DVN in a year (see circle). Chart 12 shows Chesapeake Energy (CHK) climbing above its 50-day average in heavy trading as well. The CHK:XLE ratio below Chart 12 has just broken a five-month down trendline (see circle and line). Both stocks are natural gas producers. Some gas companies have announced cutbacks in production which should reduce the amount of supply on the market. That may help explain this week's buying of those two natural gas stocks and the late bounce in the price of the commodity. Any signs of strength in that group should just add to the rising enthusiasm for the energy sector. While that may be a short-term positive for the market, it also carries a warning. Energy leadership often coincides with stock market pullbacks.
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Chart 11
