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Weekly Energy Sector Review and Trading Plan for December 6-10

In my last post on November 21, I debated whether the XLE drop down to 54.50 was a buying opportunity or a trap. It was my opinion that it was likely going to be a trap. Well, two weeks have gone by and price is still sitting right around 54.50. It hasn’t turned out to be the trap I expected, but it really hasn’t been much of a buyable dip either. Things are just stuck in a range, but I think there might be some resolution coming this week.


I’m still leaning bearish, but I have to admit that I’ve been impressed with the resilience that XLE has shown with all the bad news that’s been thrown at the market over the last two weeks. The omicron covid news hit full force out after my article from two weeks ago, and if you would have told me XLE would still be above 54.50 after that news, I’d say that’s definitely some strength. If I was around 85% bearish back then, I’d say I’m somewhere around 70% bearish now. Still not bullish, but definitely not as doom and gloom as I was two weeks ago. There are some buyers under there. Who knows how long they last, but they are there.


Not going to lie though, this has been a difficult two weeks of trading in energy. I’ve been pinned to the sideline for most of it. There’s absolutely no way to swing anything overnight with these random 2% gaps. It makes risk control almost impossible. I tried the XLE short twice and scratched them both breakeven. All I’ve been able to do is some intraday scalps. Out of a five point fall from 59.50 to 54.50, I’ve caught maybe 1.5 points of that move. Not great, especially when I had the bearish thesis all set up. Many times making directional calls is easy on Twitter, but once you figure in the risk control and stops, things become untradeable.


So where does XLE go now? I trade a lot of other things besides energy, however I don’t post much of that stuff because readers aren’t interested in those, they are reading for energy. But, from what I can see from the other sectors of the market, I think there may be one big dip coming and then a reversal upward into the end of the year. That big dip could come early this week. I’ve been looking short, but if you aren’t already short, I don’t think this is the place to start a short play. I’m sure many will try to short the coming breakdown, but I get the feeling they may end up trapped and squeezed into the holidays. I know this probably sounds crazy coming from the guy who is bearish on energy, but the next decent play is likely going to be to the long side this week. I’m not talking long term though, I’m just looking at the next 2-3 weeks.


For me, the key to this market is IWM. Smallcaps sat in that 210-235 area for about nine months, took a shot at breaking out of the top of that range and failed. Price has now fallen back into the range and seems to want to test the lower boundary of that previous nine month range. I get the feeling that price is going to make a run at the 207-210 area soon and then we’ll see what kind of demand is there. This pattern likely ends up being very similar to a head and shoulders type situation where the bearish pattern is perfect, price breaks below the neckline and then buyers rush in. What should have been a perfect reversal pattern quickly turns into a bullish continuation pattern. That’s my guess anyway. If IWM finds demand around 207-210, then it likely makes a quick move back toward the top of the range (or at least the middle) over then next couple weeks. Who knows where it goes after that, but finding demand underneath that nine month range strongly suggests some short term bullishness.


That’s the best case scenario. The worst case would be if IWM takes a look at that 207-210 area and totally fails there finding absolutely no demand. If that happens, that opens up 170 fairly quickly. I don’t think this happens. There should be enough demand underneath to at least stop price above 200, at which point it probably bounces back up and tests 210 from below. If price fails to get back into the range at 210, then that probably starts the waterfall to 170. There should be plenty of time to get out of longs if this happens. I see many calling for an absolute crash soon, but I just don’t see it, there’s still way too much money floating around out there.


One specific area to watch this week is XBI. If IWM is an important clue for energy direction, then biotechs are important because they make up a large portion of IWM. I posted on Friday to watch the 102-107 area for major support in XBI. I expect that it will test that level early in the week and if it holds that could help produce a nice bounce in IWM. I’ll be looking for some solid structure to get long XBI within that area of demand.


The other area to watch is the smaller regional banks, KRE (as well as XLF). Banks, smallcaps and energy have been benefitting from the inflation play. These smaller financials also make up a large portion of the IWM. One thing to notice is that both KRE and XLE are very close to testing their 200 day moving averages. They should both test at the same time, and I think that test might come early this week on a panic dip in the market. If KRE holds, then XLE should probably also hold. Use all the clues you can get.


Now, to take a step back up the macro ladder, the TLT and UUP are a concern. The TLT broke that 152-153 level to the upside on Friday, which suggests that banks should probably roll over here. Given the banks/energy/smallcaps correlation, that’s bad news for energy and smallcaps. I’m not sure I trust the move in bonds though, seems like much of this move was caused by the new covid variant stuff, which I think is totally wrong and off base. The government is doing all they can to convince people this latest variant is dangerous, but all the evidence just doesn’t back that up. When the market does finally wake up to the fact that the latest variant is a complete dilution of covid, I think the market reverses back to the upside, with bonds falling quickly, especially if the inflation/taper issue comes into focus again. I could see TLT being a short play in the 156-157 area soon.


UUP is still a problem, but it seems like it might have topped out around the 26 level. The strength in the dollar usually isn’t a good thing for oil, gold and other commodities. I use the USD/CAD pair for dollar strength related more to oil and it is pressed right up against that 1.29 area which has been resistance throughout all of 2021. Even if it does break to the upside, there’s an even bigger level sitting just overhead at 1.30-1.31. The dollar strength might be running into some headwinds soon and if it tops out, that could provide some support for oil prices.


Given the strength in the UUP, gold and the miners have been crushed over the last few weeks. I pointed out in the last blog post that GDX was probably maxed out at 35 (200 ma) and that seems to be correct. It closed Friday at 30.79. The 31 area in GDX has been major support, but I think that support is slowly weakening the more times it’s tested. I liked the long GDX at 31 last time it came down here, but I’m not interested in trying that trade this time. I think GDX could make a run down and test the late September low around 28.83. I’d definitely be interested in looking for a trade down at that level, but it really depends on where the dollar tops out on this run. If TLT reverses back down (rates up), that could spike the dollar upward and GLD/GDX down, so it’s a tricky trade entry. One other thing to watch on gold is the AUD/USD pair. It’s coming right into support around .6900, so see if that holds for a nice bounce in the Australian dollar (and GLD).


Industrial metals (XME) is also another possible trade setup if the dollar tops out and inflation hits the radar again. There’s a great long setup in the 39 area which has been building since March. The only negative is that XME has already broken down below the 200 day moving average, but a short term bounce back up to the 50 day around 44 isn’t out of the question if this market has a Christmas rally. The trade can easily use about a dollar stop for a $4-$5 gain.


One other sector to watch is the homebuilders (ITB). It really has nothing to do with energy, but it could present a nice short play. With bonds ripping upward, that has put downward pressure on rates, which is definitely a help when buying a house. If that TLT trend (and specifically the 10 Year) tops out and moves down quickly, that could put a top in ITB. Much like the XME play, it’s another trade where you can get away with a fairly small stop for a sizable gain.


Trading Plan for the Week – My ideal situation for Monday would be a sizable gap down in IWM and the overall market for a long play. If IWM tests that 207-210 area and holds, I want to get long XLE. I’m not playing any individual energy names, just trying to catch the overall sector move with XLE. The area to focus on in the XLE trade is 54.00-54.50. If I can structure the trade around that area, then the trade can probably be sized up with some confidence.


I’ve gotten away from XOP over the last few months, but there’s also some good opportunity there. One thing to notice is that XOP went right to the 50% retracement of that run which started in August down at 72. That provides a good point to play off of early next week. It also has the 200 day ma just under that pullback point for some added support.


I’ve also noticed that XOM and CVX have totally flipped roles. For a long time, XOM was stronger than CVX, but that has changed. On this recent pullback, XOM went right to the 200 day moving average (about -11% drop), however CVX hardly budged at all dropping just 5% from highs and getting nowhere near the 200 day ma. If I had to choose one to play on the long side, CVX is the choice, especially with nice tight stop around 112.


The only other name that sets up well is one I posted on last week, NOV. It got the dip under 11.80 on Thursday and there was big demand waiting under there. I didn’t take the trade, I was biased short pretty much all week. NOV closed Friday at 11.86 and I think there’s probably a good setup there if energy makes a run. Any entry under 12 would probably work with a stop safely under that 11.45 low from Thursday. You could probably even get away with a stop just under the Wednesday and Friday lows around 11.70 if you want to size up.


The only other names that are reasonably attractive on the long side would be PSX in the 65-67 area, LNG 101-102 area and CTRA in the 19.50-20.00 area. All three of those are very tight stops with good potential for reward.


Outside of energy I’ve got a few names on the microcap watchlist. BFRI was a nice winner, but UNCY was not. I’ve still got UNCY, but not happy about it. I’ve also got positions in VECT (2.87)RCRT (2.86), BJDX (2.58) and VQS (2.29). The BJDX play is my largest and favorite play. The quiet period on that IPO doesn’t end until December 20, but once there’s news I expect that it could easily move similar to BFRI and reach the 5-7 range. Very risky low float, so definitely size accordingly. Some other names on the watchlist, but no position yet: DRMA, CELZ, SQL, VIRI, VRAR, PPTA, TIVC, STRN and MCLD.


In summary, I’m bearish longer term, but looking for a long play short term into Christmas. I’ll be watching the action Monday looking for a nice panic capitulation type flush and if I get it, I’ll be looking for some solid structure to get long XLE. I’m really not interested in trying anything short overnight, only intraday scalps on that side if applicable. If the market opens up big Monday, I’m not chasing energy and will probably move to trading XBI or IWM.


It could be a very volatile week, so good luck out there and be safe.

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