Energy Bar – XLE

by Dan August 18, 2016 3:22 pm • Trade Ideas

In case you missed the headline:


That was a fairly epic short term bounce right from the nice round number and level most technicians might have identified:

Crude 1yr chart from Bloomberg
Crude 1yr chart from Bloomberg

Just as the commodity found technical resistance in the late Spring in and around the nice round number of $50, it may do so again after such a sharp rise.

The ytd chart of crude vs the U.S. dollar index (DXY) is all you really need to see to understand the new found crude bull market. And this is oddly happening as economic data increasingly supports rate increases:  

[caption id="attachment_65768" align="aligncenter" width="600"]DXY vs Crude ytd from Bloomberg DXY vs Crude ytd from Bloomberg[/caption]

Despite the volatility in crude and the dollar over the last few months, the XLE the S&P Energy Select etf has traded in a fairly tight range between $65 & $70, with today making a new 2016 high breaking out of that range:

[caption id="attachment_65769" align="aligncenter" width="600"]XLE 1yr chart from Bloomberg XLE 1yr chart from Bloomberg[/caption]

One reason for the relative stability in the XLE is the fact that the top three holdings Exxon (XOM), Chevron (CVX) and Schlumberger (SLB) make up 41% of the weight of the etf, with dividend yields of 3.4%, 4% and 2.4% respectively.  Best of breed mega-cap e&p and services companies whose 2 year earnings and sales declines have likely troughed.

If that is the case, and earnings were to pick up, then valuations will start to look a lot more palatable, buybacks will pick up (all have slowed the pace dramatically in the last year) and this thing could be a straight shot to the low $80s:

[caption id="attachment_65770" align="aligncenter" width="600"]XLE 2yr chart from Bloomberg XLE 2yr chart from Bloomberg[/caption]

As The Dude would say “this is a very complicated situation”. While the Fed appears very ready to raise interest rates, they are less likely to do so at their Sept or Nov FOMC meetings prior to the Presidential election (my thoughts here from yesterday), but assuming no external shock they will likely raise in December at the very least, for only their second time since June 2006 and the first since last December.  This is important because rising interest rate expectations should cause the dollar to rally and commodities like oil to sell off.  Maybe there is some Goldilocks scenario that I am not thinking about correctly (like a pick up in demand for oil and a one and done Fed) which could offset the adverse affects of a stronger dollar into a rate hike. But the dollar seems to be back in the hurt locker, rates don’t go higher and oil went from looking like it was ready to breakdown, possibly back towards the low $30s to now testing a new range.

The XLE should show relative strength to the commodity, but timing is important and defined risk strategies may make sense as if for any reason in the not so distant future we are to get a vol shock like we saw last summer or in Q1, oil and related stocks will likely be at the eye of the storm.

Since the XLE has bounced towards resistance near term entries for new longs may be best served to wait for a pullback towards the 50 day moving average (about $3 lower), or for those that want to play for a breakout with an entry now, it may make sense to fade the recent move by selling a near term call in order to finance one farther out towards the end of 2016. For instance, the Sept 2nd weekly calls can be sold at .40 and the Dec 72 regular calls can be bought for about 2.50. The Sept calls expire before Labor Day weekend and if worthless will have protected the Dec call buy from both decay and if there’s a pullback near term in XLE. After Labor Day the Dec could set up nicely for a breakout into year end.