By James Hyerczyk
Commodity Trading Advisor
Crude oil sensitive stocks rose sharply last week, driven higher by positive developments in Europe. Investors will be looking for further upside action this week now that it appears that Euro Zone officials may have moved closer to solving their 30-month sovereign debt problem. A follow-through rally in the major indices this week will be a strong sign that investors are giving Europe the benefit of the doubt. This could mean risk is back on, giving equity and commodity markets a boost.
Besides being driven by the strong rally in the general equity markets, oil companies also benefited from the sharp rise in crude oil prices. August crude oil prices soared on Friday as traders scrambled to cover shorts after European leaders stabilized the region’s banking system, triggering a massive shift in investor sentiment. Although this news event was cited as the main reason for the up move, this week could see similar action as potential supply risks from the Middle East may crop up if Iran decides to rattle its saber over the start of the European sanctions.
Some traders believe that the impact of the European Union sanctions against Iran’s oil exports, effective July 1, could already be factored into oil prices. Last week, Iraq’s Deputy Prime Minister for Energy Affairs told CNBC that crude oil prices may be close to finding a bottom. “$85 to $90 for Brent…I think that’s about the bottom,” he said. If Iran follows through on its threats to close the Strait of Hormuz, crude oil prices could soar.
Oversupply is still the most negative factor driving crude oil prices lower, however, if supply is threatened, shorts will continue to cover and speculative buying is likely to increase.
If the financial situation in Europe remains stable this week then crude oil traders will have no choice but to focus on possible developments in the Middle East. Selling pressure is likely to be light as traders take a neutral stance rather than risk being caught on the wrong side of a news driven event. Energy stock traders should keep an eye on the broad market movement as well as crude oil prices this week. Several oil stocks and an energy ETF could benefit from both a rise in the major indices and higher crude oil prices.
The S&P Select Energy ETF (XLE) rallied sharply higher on Friday, helping to form a new main bottom on the weekly chart at $61.11 and putting the market in a position to breakout above seven weeks of highs.
An initial thrust this week should lead to a test of the downtrending Gann angle at $67.00. If upside momentum remains strong then the rally should continue until it reaches a key 50% level. Based on the main range of $76.50 to $61.11, a major retracement zone has been formed at $68.81 to $70.62. This zone is a potential near-term target.
Exxon Mobil, (XOM), reversed course on the weekly chart to post a solid gain on Friday. The rally helped form a new main bottom at $77.13 while setting up the market for a potential test of the series of main tops ranging from $87.52 to $88.23.
Strong upside momentum over the near-term could drive XOM to a new 52-week high, triggering an eventual move to the May 2008 top at $96.12. Stronger demand for equities and commodities will be the catalyst behind this move.
After bouncing off of an uptrending Gann angle several weeks ago, Royal Dutch Shell (RDS.A), formed a main bottom at $60.62 that was confirmed by the last week’s solid rally. This week this support angle moves up to $62.29.
Although Friday’s strong finish was not a trend changing event, the fact that the stock closed in a position to breakout over a key retracement zone at $66.35 to $67.70 is a strong indication of higher prices to follow.
A follow-through rally could mean a test of a downtrending Gann angle this week at $70.35. A move through this angle will be a sign of strength, but the main trend will not change to up until the swing top at $72.07 is violated.
Another oil stock that is poised for an up move is British Petroleum (BP). Last week’s strong close has placed this stock in a position to pop through the last swing top at $40.59. A move through this price will turn the main trend to up on the weekly chart.
In addition to the swing top, this stock is also in a position to breakout above a downtrending Gann angle at $39.84. This could set up the market for a further rally into another downtrending Gann angle at $44.09. This price is slightly below the major 50% price level at $44.57 that remains a major hurdle for this stock along with the Fibonacci retracement level at $48.77.
There is no question that last Friday’s rallies in both crude oil and the major stock indices were impressive, but there is still some suspicion that they were the result of aggressive short-covering. New buying is what is going to drive these markets higher, but this may not occur until crude oil and stocks retrace some of their substantial gains.
The key is to remain patient if investors shy away from buying strength and to be ready if these markets form a secondary higher bottom after a retracement of Friday’s strong gains. Energy stocks are likely to follow a similar path, but these stocks are going to need a boost from equities and crude oil. They should also benefit if the crude oil market heats up due to supply concerns in the Middle East.