Tuesday, November 10, 2015

Oil's Reaction to Fed Rate Hikes

Let's talk about oil, and let's talk about rate hikes. Let's talk about how afraid energy investors are of the stricter monetary policy that has come to destroy their beloved (and lucrative) oil and gas stock that can't operate effectively with such low commodity prices. Many oil companies who are struggling to continue cutting costs are experiencing a cash drought that doesn't show any hints of amelioration. Price-to-earning valuations are continually getting more expensive, but not because of an ineffective cost structure but waning revenue and cash flow. The only way to be evaluated as an inexpensive stock, for the near future, is cutting costs, and we have seen that firms are doing that with OPEC and the EIA projecting significant investment cost cuts by the next year. Some oil majors like BP and Shell have abandoned discovery projects in the arctic region and some Asian states, something that is not advantageous as the global economy tries to escape a slowdown and the largest central bank prepares for tighter monetary policy. Barring bottom line concerns, most energy companies are fixated upon boosting their top line revenue levels with hedging and raising prices where they can. That means downstream prices (the price at the pump) might see more increases than are expected at low oil prices because consumers in the fuel market have little bargaining power over price with an inelastic demand curve. Drivers will always be driving so gas will always be needed, even if the price of gas is $4/gallon. Although, we do know that lower gas prices stimulate more consumption, so firms still do have an incentive to keep consumer prices lower in order for that driver to fill up those extra tanks. Nevertheless, despite downstream profits, many smaller producing and distributing companies are accepting very large levels of debt for their operations in hopes of surviving through the end of the glut. They are less likely to cut major operations off because they make up such a large amount of the revenue streams. Now, we are at this point where a majority of investors and executives think that borrowing will get more expensive within the end of the year, so let's look at investor's opinions when trading oil and gas related securities.

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First up is something a little broad. We've got a 10-day, 15-min chart that reaches right back to the end of the October Fed meeting on the 28th. Against the market average, the Energy Select Sector SPDR Fund (XLE) outperformed the market despite volatility in the oil markets. In fact, a jump of almost 2% showed elation over another month of low rates even though a stern consideration of December hikes was delivered. October 26th trading session opened 2.43% higher for the energy ETFm while the S&P 500 only saw gains of 0.77% on the day. At its peak after probabilities of rate hikes increased, the SPDR Energy Fund was over 9.05% from its start on October 28th, a seemingly healthy reaction with bulls supporting S&P growth of 2.25% with significant volume, especially at the opening of the November 3rd session. From the peak, we see energy stocks declining faster than the market average with losses at -4.50% (compared to market losses of about -2%). Overall, energy stocks are showing more volatility on a weekly and sometimes daily basis. There is definitely more uncertainty surrounding those stocks concerning both fundamental valuation and technical strength. In the overall market, the S&P 500 ADX indicator reveals more downside volume as shown by the peaks indicated which trump the upside peaks in the rectangle. For that reason, look for a bearish trend to dominate S&P Energy trading with the persistence of general downside pressure absent an upside force strong enough to buy into gains.

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Up next, we're going to look at the most popular ETF fund following crude oil future contracts, iPath S&P Crude Oil Total Return (OIL). On the day the Fed preserved low rates, OIL jumped almost five percent as it was complimented by bullish production data that week as well. Before a peak on November 3rd, we can observe two major buying periods that made the ETF outperform the market average tremendously. The ADX line shows significant demand forces behind both of the identified buying periods, but the blue ADX line never topped its previous high, a generally bearish indicator. Looking at the contrived trendlines from the volume pressures, a downward sloping line can be drawn for bullish volume and an upward slope for the bearish volume. The main ADX (blue) line shows selling forces just recently overcoming buying forces and causing the sell-offs seen after a peak of 8.31% gains from the Fed's meeting to now. Two major selling periods can be observed on November 4th and November 6th where both sessions opened with an OIL plunge and not capped with a recovery. Various downside trendlines show OIL price dropping below the level at which it started (Oct 28) and continue losses of -7.95%. Technicals haven't weakened without reason. Valuation of the oil markets has been shifted down with rate hikes brought into the picture as well as the persistence of deflationary pressures on the world's energy demand. Larger buying sessions (cashing in of short sells) may signal that investors have found an appropriate price to trade at, so keep an eye on the volume of any attempted rebounds. Otherwise, sell and short a little while longer.

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Finally, we'll talk about some large oil companies who are currently performing better than the market average and are just now coming down to pre-FOMC meeting levels after probabilities for rate hikes in the near future have risen significantly. Once again, we see a steady rise on price from just after October 28th to peaks on November 3rd. There seems to be a bit of technical weakness across energy stocks developed on that day despite flat movement from the S&P 500. Bullish volume reaches its highest here as well and never emerges to this level for the next 5 sessions. The arrows show a repeated, general pattern where bullish volume is decelerating and bearish volume is accelerating. We're seeing higher highs during selling sessions with the main (blue) ADX line strongly bearish. These volume statistics are for Exxon-Mobil, but can be considered similar to other oil majors. Plotted on the chart are Exxon-Mobil, Shell, and Halliburton, each with similar directional patterns. Trendlines have been drawn in the in the respective color, and all move in a bearish direction (just like previous trendlines). Nevertheless, we've seen, over the past three sessions, bounces off those trendlines into flat movement as opposed to bearish losses. Currently, there should be some consolidation as bearish mentalities build up in the face of rate hikes similar to the movement of the major market index. Despite cooling down in energy technicals, oil and gas firms should hope that valuation does not catch up to companies fraught with debt and facing default because of low energy prices. Price-to-earnings data backs up the fact that the energy sector is becoming more expensive, especially with a stronger dollar. At the beginning of quarter four, this sector led a bullish surge which garnered strength from a crude oil recovery and technical rebounds after a horrible third quarter. Looking forward, expect softer returns from the sector as well as sideways running into the December Fed meeting.

1 comment:

  1. Jacob,

    The primary driving force behind the price of Oil is a very weak worldwide Economy and the second largest producer in the world determined to keep Market share so they continue to produce at, or near, their full potential into an oversupplied Market that is, again, exceptionally weak.

    Additionally, there is at present a worldwide race to the bottom in Currencies. Every Developed and most of the Emerging Markets have instituted some form of stimulus to produce growth. Some of them are genuinely trying to use Monetary Policy to get their Economies growing like Europe, others are simply manipulating their Currency to support an Economy bent on continuing to be the Manufacturer to the world, China. There is but one Country not in the race at present, the United States. We certainly were, but we dropped out. We are the only Country in the world that is about to move Rates higher, for the first time in almost ten years.

    That makes the dollar very attractive compared to everyone else. Our Rates are already among the most attractive in the world, when you add in that our Capital Markets are the deepest and most liquid in the world that makes a Capital flight to dollar assets a fait accompli. So what would you rather hold, a Commodity that is being over produced in a world awash in it that is very weak, or, an Asset that is appreciating and is by far the most liquid in the world? When the you know what hits the fan there is nothing more important than liquidity...and very soon the shit is going to hit the fan.

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