Further Declines or Rally in Oil Stocks?
Based on the December 17th, 2013 Oil Investment Update
In our previous commentary, we examined the situation in oil stocks. Back then, we wrote in the summary:
(...) the outlook for oil stocks remains bullish and the uptrend is not threatened, however, taking into account the medium- and short-term sell signals, further deterioration should not surprise us.
Since that essay was published, we have seen a downward move which took the oil stock index below 1,440. Did this weakness change anything in the overall outlook? Before we try to answer this question, we'll examine the NYSE Arca Oil Index (XOI) in different time horizons and find out if there's something on the horizon that could drive oil stocks higher or lower in the near future. Let's start with the long-term chart (charts courtesy by http://stockcharts.com).
On the above chart, we see that the situation has deteriorated recently. The oil stock index extended its declines and dropped below the upper line of the rising wedge. From this perspective the breakout that we saw in October was invalidated, which is a strong bearish signal and we may see further deterioration.
To see the current situation more clearly, let's zoom in on our picture and move on to the weekly chart.
In our last essay on oil stocks from Dec. 12, 2013, we wrote the following:
(...) the position of the RSI and the sell signals generated by two other indicators, encouraged sellers to act and triggered further deterioration this week. (...)the upper line of the rising wedge was broken, therefore, the first target for the sellers will be around 1,439, where the bottom of the previous correction is.
Looking at the above chart, we see that the XOI reached its target in the previous week. With this downward move, the oil stock index reached the medium-term support line based on the June and November 2012 lows, which had successfully stopped declines earlier this year. We saw such situations in June, August and also in October. From this perspective, if history repeats itself once again, we may see similar price action this (or next) week. Nevertheless, this time, before we see higher values of the XOI, the buyers will have to break above the upper line of the rising wedge, which serves as major medium-term resistance (currently around 1,463). If they manage to do that, we may see an upward move to at least 1,483 where the resistance level created by the previously-broken 2013 high is. The next upside target will be the psychological barrier of 1,500.
What could happen if the buyers fail? If the sellers push the XOI below the medium-term support line, we will likely see further deterioration and the downside target will be the psychological barrier of 1,400. If it's broken, the next target will be around 1,376, where the bottom of the Sept.-Oct. correction is.
From the technical point of view, the medium-term uptrend remains in place at the moment, and the situation is still bullish.
Now, let's turn to the daily chart.
Looking at the above chart, we see that the XOI declined in the previous week once again and dropped below the bottom of the corrective move that we saw at the beginning of November (at 1,439). In this way, the oil stock index also slipped below the upper line of the rising wedge (marked with the black thin line) and two medium-term support lines (the upper one is based on the June and August lows and the lower one is created by the June and October lows). However, when we take a closer look at the chart, we see that the XOI reversed course after reaching the 38.2% Fibonacci retracement level based on the entire June-November rally. As you can see on the daily chart, this support encouraged buyers to act, and resulted in an upswing, which push the index above the May high.
Despite this growth, the combination of the previously-broken upper medium-term rising support line and the upper line of the rising wedge stopped further improvement and the XOI closed Monday below this resistance zone. If the buyers do not give up and the oil stock index comes back above this line, we may see an upward corrective move to at least 1,456-1,461 where the 50-day moving average and the previously-broken neck line of the head and shoulders pattern are. On the other hand, if the buyers fail, we will likely see a pullback to the lower rising support line (currently around 1,435) or even to the Friday low at 1,421.
Summing up, from the long-, medium- and short-term perspectives, the situation has deteriorated. We saw an invalidation of the long-term breakout (which is a bearish signal). On the other hand, oil stocks reached very a important medium-term support line based on the June and November 2012 lows, which had successfully stopped declines earlier this year. Additionally, the XOI reached the 38.2% Fibonacci retracement level based on the entire June-November rally, which suggests that the sentiment for oil stocks may turn positive in the near future.