Wednesday, October 23, 2013

Energy stocks, crude oil and the USD: they're out of synch

Yesterday I wrote about what appeared to be a shift in sector leadership, with energy stocks in particular showing strong signs of relative price emergence.


Just to elaborate on what I pointed out yesterday, the chart above shows the Guggenheim equal-weight energy ETF (RYE) vs. the equal-weight S&P 500 ETF (RSP). The relative performance for RYE exhibits a double-bottom pattern for April and July followed by a recent breakout of a triangle formation -- all bullish attributes.

However, crude oil (WTI) has been behaving quite differently of late.


Rather than heading north like energy stocks, the associated commodity has been heading south since the start of September. I have been bullish on crude oil for months and I remain so for a few reasons. For one, as shown in the chart above, crude oil (WTI) broke out of an ascending triangle in July, shot up beyond $105, peaking at $110, and has since given back all those gains. Note $110 appears to be resistance and $97 looks to be support. Currently WTI is about $98, recently falling below round-number $100, but still above support at $97. The bottom line is crude has not broken down and still qualifies as a pullback off an earlier bullish breakout.

Another reason I remain bullish on crude is the US dollar (USD). Earlier this month, I discussed my bearish take on the USD, including what appeared to be a complex head-and-shoulders formation with an already-breached neckline (important).


The chart above shows the head-and-shoulders pattern for the USD with the breakdown through the neckline at the 81 level. There appears to be support at 79, which could serve to stall the USD's descent, but to me this chart continues to look bearish.

As I've reminded here before, historically there has typically been an inverse correlation between the USD and commodities in general -- which includes crude oil.


The chart above shows crude oil (WTI) in the upper inset, the USD, followed by the rolling three-month correlation between the two. The inverse relationship is clear when observing crude oil's chart versus the USD, an approximate mirror reflection. Note the rolling three-month correlation has tended to be less than zero (negative) over time. What's interesting is when the correlation spikes into positive territory, especially when reaching 0.50 or higher. Such instances are rare and do not last long. Currently the rolling three-month correlation is 0.77, the highest reading since 2005. Both crude oil and the USD have been in-synch, declining together, but as displayed such a positive relationship is out of the norm and very likely to change imminently. The question is: which will rise and which will fall? I've already weighed in with my opinion, believing crude oil holds and eventually resumes its ascent as the USD continues to erode.

Finally, an additional reason I remain bullish on crude oil is due to another relationship I've discussed in the past.


Between energy equities and their associated commodity, crude oil, it's my experience that the equities tend to lead the commodity. That said, and viewing the exhibit above, I have to think crude oil will soon regain its footing and revert upwards. The chart of RYE has broken out of a massive ascending triangle and is hitting new highs. And yet crude oil has been weak and in decline, despite the strength in energy equities.

I would also point out that the rolling three-month correlation for energy equities and crude oil tends to be positive (not surprising), but as shown above, this correlation is currently at -0.59, registering a 10-year low. It's very unlikely energy stocks and crude oil will continue to move in opposite directions. But as with the USD and crude, the question is which will head higher or lower? Will energy stocks revert down with crude oil, or will the commodity hold and resume its upward trend (note in chart above, the rising trend (red line) for crude oil)?

As I've stated, experience and weight of the evidence suggests crude oil will hold and eventually rise, closing the divergence with energy stocks. Stay tuned.
(Source for all charts above: Stockcharts.com)

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