Oil Stocks - The Short-Term Consequences of The Long-Term Support
Article originally published on July 8, 2014, 2:26 PM and is based on the July 4, 2014 Oil Investment Update
The end of the first half of the year, the second quarter and June are behind us. Without a doubt, it was a good time for crude oil. Since the beginning of the year, light crude climbed from the Jan. low of $91.24 to a nine-month high of $107.68 in the previous month and erased almost 80% of the Aug.-Jan. decline. But are these numbers as bullish as they look at the first sight? Not really - especially when we compare them with the current situation in the XOI. When we take a closer look at oil stocks, we see that during the last 6 months they not only climbed above the 2013 high, but also erased entire 2008 decline, hitting an all-time high of 1,730. At the end of June, the XOI declined below the psychological barrier of 1,700 and still remains below it. Does it mean that the recent rally in oil stocks running out of steam? Let's examine the NYSE Arca Oil Index (XOI) from different time horizons and find out what can we infer from the charts (charts courtesy by http://stockcharts.com).
Let's begin with the long-term chart.
In our last essay on oil stocks, we wrote the following:
(...) the XOI remains between the May high of 1,638 and the May low of 1,599. If the oil stock index moves higher from here, the upside target will be the 2008 high of 1,663.
As you see on the above chart, the situation developed in tune with the above-mentioned scenario and the XOI climbed above its upside target, hitting an all-time high of 1,730 in the previous month. From this perspective, we see that although the oil stock index gave us some gains, it still remains above the 2008 high, which is a positive signal. Therefore, we think that as long as there is no an invalidation of the breakout above this resistance, another attempt to move higher can't be ruled out. Nevertheless, we should keep in mind that the RSI is still overbought, which suggests that a pause or a correction (if the indicator generates a sell signal) in the coming month should not surprise us.
Will the medium-term chart give us any interesting clues about future moves? Let's zoom in on our picture and move on to the weekly chart.
Looking at the above chart, we see that the XOI reversed, which resulted in a bearish dark cloud cover candlestick pattern. Although this formation is not a serious threat to the uptrend, we think that its combination with an invalidation of the breakout above the psychological barrier of 1,700 and current position of the indicators prescribe caution before making investment decisions. As you see on the weekly chart, there are negative divergence between the CCI and the XOI. On top of that, we noticed similar situation in the RSI, while the indicator stays above the level of 70. In our opinion, all the above suggests that we will likely see another downswing and a re-test of the strength of the previously-broken upper line of the rising trend channel (currently around the key level of 1,600) in the coming weeks. Nevertheless, we should keep in mind that before we see such price action, oil bears will have to push the XOI below the 2008 high of 1,663.
Having discussed the medium-term outlook, let's turn to the daily chart.
From this perspective, we see that the XOI declined below the lower border of the rising wedge at the end of the previous month. Although this was a strong bearish signal, the oil stock index didn't decline sharply, instead, we saw a consolidation between the June 26 high and low. At the beginning of the previous week, oil bulls tried to invalidate the breakdown, but they fail. Despite this defeat, the XOI is still quite strong, therefore, it seems to us that we'll see another sizable downward move only if it breaks below the lower border of the consolidation. Please note that the current position of the indicators suggests further deterioration as sell signals remain in place. If this is the case and we'll see a breakdown, the initial downside target will be around 1591-1600, where the support zone (created by the 38.2% Fibonacci retracement and the psychological barrier) is. Nevertheless, we should keep in mind that as long as the oil stock index is trading around the upper line of the consolidation, another attempt to invalidate the breakdown and come back to the rising wedge can't be ruled out.
Summing up, the long-term outlook for oil stocks is still bullish as the XOI still remains above the 2008 high. Although from the weekly perspective we don't see any important technical resistance levels that could stop rally in the near future (except the June high), the combination of a bearish dark cloud cover candlestick pattern, an invalidation of the breakout above the psychological barrier of 1,700 and current position of the indicators suggests that correction in the coming week (or weeks) should not surprise us. In our opinion, if the XOI drops below the 2008 high, the current correction will accelerate and the next downside target will be around 1591-1600, where the support zone (created by the 38.2% Fibonacci retracement and the psychological barrier) is.