Energy Part Two

Nobody knows for sure where oil prices are going – but, as investors, the data is interesting to analyze and consider as we look for opportunities to benefit from this sector.

 

We will be reviewing the following components and their relationship to one another, energy, and the stock market in an effort to better understand the potential opportunities and current market:

 

USO, UUP, Stock positions, rig counts, oil prices, metals, inflation, and GDP (nomenclatures described below)

 

Let’s review crude prices over the past several months.

 

  • USO – ETF (Exchange Traded Fund) seeking performance corresponding to the spot price of West Texas Intermediate (WTI) light sweet crude:

    • Somewhat flat base being formed – 1-6-14 – the USO closed at $18.05 – and after trending sideways for several weeks now with some up days and some down days – closed Friday 27th at $18.10. The USO is currently right below the 50-day moving average.  This sideways pattern represents very healthy consolidation.  The 50-day moving average is currently reflecting some resistance around $18.70 – but if we should see WTI break above this resistance level with healthy volume then it could very well become a new floor.  Certainly supply and demand are at the root of this price action – but technical analysis illustrates the money flow as it relates to the price of oil both today and a glimpse into what speculators anticipate future prices to be.

To help with our understanding of why gas prices and energy costs have changed so much – consider the price movement in WTI since July 2014.  (Price per barrel)

                                                               

 

July 20th, 2014                 $102.09

August 31st, 2014              $92.71

Sep. 28th, 2014                   $89.74

Oct. 26th, 2014                    $80.54

Nov. 30th, 2014                  $65.96

Dec. 28th, 2014                   $52.69

Jan. 25th, 2015                    $48.99

Feb. 27th, 2015                   $49.44

 

As you can see – more than a 50% drop in a very short period of time – this will have an effect on corporate earnings – thus GDP.

 

 

  • UUP – ETF – seeks performance corresponding to the Deutsche Bank long S. Dollar index futures index.

    • The US dollar typically will show a divergence (move the opposite direction) to most commodity prices including oil. It has been interesting to follow the price action of the dollar as well over the past few months.

      • Closing Prices of the UUP (see above for description)

 

June 30th, 2014                  $21.26

Oct. 3rd, 2014                      $23.08

Dec. 31st, 2014                   $23.97

Jan. 23rd, 2015                    $25.21

Feb. 27th, 2015                   $25.20

 

 

 

Two Items to consider: 

 

1 – Notice the similar consolidation and price movement between the USO and the UUP from early January to Feb. 27 of 2015.  The USO (top of page) represents WTI and the UUP represents the US dollar.

 

2nd – As the UUP (index corresponding to the dollar) has increased since June 30 just over 18% the price of WTI (Oil) has declined from just over $104.00 per barrel to just over $49.00 per barrel on Friday Feb. 27th.

 

So how have some of our oil-related positions moved in price in recent months as a result of this data?

  • WLL / NOG / SYRG (holdings many of you may have)

    • Prices for the following dates: 12-16-14 to 2-27-15 (Low of … to …)

    • Symbol 12-16-14               2-27-15

    • WLL $24.13                     $33.83

    • NOG $4.79                       $8.62

    • SYRG $8.14*                    $11.95            *(Low as of 12-11-14)

 

 

 

The dollar is certainly a part of what we have been seeing in price movement – yet supply and demand are changing daily as a result of production and increased demand – Consider the following:

  • Rigs that have been shut down – rigs no longer producing (offline) as a result of lower prices making it difficult if not impossible to make money at the moment.

    • Some experts believe the total number of rigs being shut down over a nine month period could exceed 650 – 40% of where we were at the peak. As of Friday – going back to October – we’ve already seen more than 600 oil rigs taken off line.

 

  • Oil prices just might be anticipating something

    • The real question then – is it reasonable to believe that oil prices are at the very least in a period of real consolidation? This consolidation may very well prove to be forming a new base (as the charts are pointing to) for the next move up in crude, if in fact supply and demand begin to tighten as a result of fewer rigs on line and corporate production and consumer spending increase as a positive result of temporarily lower energy costs. We certainly cannot know definitively whether corporations and consumers will put that extra cash to work – but history suggests it is wise to pay close attention..

We also have exposure in the Metals – one position being NEM (Newmont Mining). Keep in mind commodities in general tend to have a negative divergence to the strong dollar.  This is why the movement in NEM is so interesting:

 

NEM Closing Prices

 

16th, 2014 $17.78

1st, 2015 $19.34

16th, 2015 $22.29

30th, 2015 $25.15

20th, 2015 $25.58

27th, 2015 $26.33

 

  • What about inflation and interest rates? What if we do see increased productivity, wage increases, and more consumer and corporate spending – to name a few things that may result from the current lower oil prices – could that create an inflationary environment?  History would teach us to be prepared for that very thing.  It has the potential to be the perfect storm – which may create the catalyst for the FED (Federal Open Market Committee) to begin tightening interest rates in an effort to keep inflation under control.  This data would ultimately be a positive as it would indicate people are going back to work and when the labor market tightens wages tend to increase – thus putting money in the consumers (70% of the US economy) pocket.  One additional impact could be a period of P/E expansion, a time when the price / earnings multiple will be in an expansion phase as earnings are growing relative to underlying prices.

 

  • GDP (gross domestic product) – How will lower oil prices, even if temporary, change the GDP picture here and around the industrialized world? Example – recent #’s from the Eurozone –growing GDP a bit better than expected with Germany leading the way.  Things appear to be stabilizing in their economy as lower oil prices may be a real blessing to many of Europe’s companies just as it is here in the US.   For many companies this is a real boost to margins and can result in increased production followed by hiring and wage increases.

For more detailed information on the recent #’s from Europe, Google Eurozone GDP or European GDP growth and you see several good options with a good breakdown of each country and their respective #’s.

 

In summary, the recent drop in oil prices shows signs of consolidation and may begin to trend up some. However, the net effect could be very positive for corporate margins and earnings in coming quarters.  The drastic movement down in oil prices has created some real opportunities for us as investors.

 

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