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Energy Equities Outlook: Huge Short Opportunity Coming

It has been a great two weeks away and some much needed rest and clarity. Sonoma was a beautiful place and a drive up the coast of California was a great thing to do, I highly recommend it. I see that the bears got totally roasted while I was gone. That was very similar to the last chart I posted before I left. Once XOP broke that 22.68 level and took out the downtrend line, the squeeze was on. That move last week should have cleared out almost all the short positions. If there were any shorts left, this week’s early action should clear out the rest of them. That was a lot of buying power used up and those guys will probably be looking to put those positions back on in a big way soon.


The big news over this weekend seems to be the drone strikes in SA taking out refining capacity and causing some temporary shut-ins. Don’t fall for the hype on this one. Anyone who chases this action is going to get burned. The geopolitical risk premium just isn’t what it used to be years ago. The oil price/shale stocks correlation just isn’t there anymore. US shale companies are reacting and moving based on different factors unrelated to oil price. Shale companies have their own set of unique problems and drivers. Just because oil spikes up, it doesn’t mean that these stocks will see a sustainable spike in price.


As for the news and rumors themselves, I’m not totally sold on the fact that these are accurate. SA wants price up, so why waste a perfectly good crisis? A little exaggeration of what is going on helps their cause a great deal, so why not overstate things a little? Why not shut down for a couple days and spike the price, send some fear into the market and put everyone on edge? Seems like a perfectly reasonable plan to me. The only problem is the market will become even more desensitized to the geopolitical problems and that’s one less factor to hold price up. You can cry wolf a few times, but eventually everyone catches up to what’s going on.


A quick review of the XOP shows a nice little base between 20.75 and 22.68, which the market broke from on Monday morning (Sep 9). It moved up to 24.57 midday Tuesday and then simply drifted lower the rest of the week. The spot to watch is the breakout point of 22.68. The market made a run at that level on the open Thursday morning and held, but the bounce off it was very weak. The 8 day moving average is sitting at 22.97, while the 20 day moving average sits at 22.13, and the 50 day moving average at 23.35. XOP closed at 23.42, which is just a few ticks above the 50 day. In summary, the market broke out of a little base, but the action was fairly weak and doesn’t inspire much confidence that it can continue.


So where is it headed now? Given the weekend news, I would expect a nice gap and run for the early part of the week. It’s possible that we could see a little 10% run which takes XOP up near the 26 level and it’s likely that it could even push 27 if the market overreacts, especially with the SPY looking to make new highs. The SPY will be the controlling factor this week as it sits at all time highs. Does it keep going or are we at a failure point into the toughest month of October? If it runs higher, I think XOP can reach 26-27, if it rolls then the XOP probably tops out 25-25.50.


A couple of other things to watch for clues are the IWM and XRT. The IWM has just been ripping straight up and now sits at an important inflection point. If it can take out 161, this would likely send energy stocks upward. It’s the same story for XRT at the 46 level. Both of these are good gauges of the economy (and the recession speculation) and are moving on similar influences as XOP.


Trading Plan for the Week: I’m not chasing this on the long side. I don’t think the market is going to sustain the momentum on this geopolitical hype. The market will look past this stuff as it has just gotten desensitized to it. Remember the Strait or Hormuz hype and how that fizzled out quickly? Years ago that would have sent prices flying, now the market just shrugs it off, mostly because the sector is moving on different drivers.  I think we are going to get a spike up on an overreaction and that is the point I want to short. I’m not exactly sure where the point to get short will be, but I suspect it is somewhere in the 26-27 area.


If this market attempts to take out 24.57 and fails, then energy stocks are toast. These rumors and geopolitical news should at least be enough to break the recent highs, but if it doesn’t that is a screaming signal that the sector is in real trouble. The opportunity to run is now for energy and if it doesn’t go then things could roll over and get ugly. I’m talking 17 range ugly. No matter what the government stats and talking heads say, recession is getting closer, not further away. The election will hide this, but it’s there. When recession finally hits, oil is going to be the first casualty. Be careful listening to ‘news’, there’s a much larger agenda behind everything you hear.


One other thing that bothers me about this latest rotation into energy stocks is that it isn’t fundamentally based. It’s fast money attacking a sector which is less than 5% of the S&P. It’s a year end quick hit to make some fast profits in a sector that can be easily manipulated, especially when there is fear and rumors like we have this weekend. There is some big money trying to make some year end gains and that usually ends up being a very short term event. When that big money wants out, the bottom can fall out of this sector in mere days. Just don’t get caught in the hype that this is some kind of major turn for energy, because it isn’t, it’s just fast money looking for the quick fix.


So in summary, I’m sitting out the early part of the week. I’m going to let this run as far as it can and then I’m putting on a large short position. It will be a slow scale in, but I think it could be a really large opportunity. I hate to be a downer and rain on the bulls parade, but my bias is shifting back to the bearish side after this latest bounce. I think there is some room to move up from here, but the risk/reward for a short becomes very attractive in the 26-27 range. The real trick, as always, is timing it right.

Enjoy the rest of the weekend and be really careful getting caught up in the news hype on Monday.



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