The energy panic caused by Hurricane Katrina could lead to a significant top in the energy stocks. Despite the solid fundamentals, sentiment towards energy stocks has remained at over-exuberant levels for over a year – a feat only surpassed by technology stocks in 1999. I do not believe that this top will represent the ultimate high for energy stocks but I do believe it will lead to a top for the remainder of the year. While it is difficult to short stocks that have strong momentum, traders should remain cautious going long and investors should lighten their energy holdings. The energy stocks as measured by the I-Shares Global Energy Fund (IXC) have traced out a similar pattern to the Dow Jones Industrials in 1987 and 1929. I believe the recent spurt higher represents the final blow-off top for these stocks prior to a serious correction.
The DeMark Sequential ™ indicators are also giving credence to the timing of a top in the sector. The IXC, Oil Services Index (OSX) and Energy Select SPDR Fund (XLE) will hit a Weekly DeMark Sequential ™ 9 reading this week indicating that prices are extended. In addition, the IXC and XLE will hit a Monthly DeMark Sequential ™ 13 in October. A monthly 13 is extremely rare in my experience and indicates prices are extremely extended.
Sentiment towards the stocks, as measured by the Rydex Energy and Energy Services funds, has remained at "exuberant" levels for over a year. According to Jason Goepfert at Sentimentrader.com, the total dollar value of assets in the two funds is $373 million, which is even higher than in technology Rydex funds in 2000 and 2001. Obviously, Rydex funds have increased in popularity since 2000 but relative the respective market sizes, I believe the value of assets in the two Rydex Energy funds, especially in the Energy Services fund, represents a bullish extreme.
Source: Sentimentrader.com
The volume in Oil Service Holders (OIH) and Energy Select SPDRs has picked up dramatically after the last correction and rally. I believe this volume expansion represents an increase in speculation, which is typically found during blow off tops. In addition, the OIH and XLE charts also reveal that the latest rally has hit the top of the trend channel. Finally, the quality of the last rally has deteriorated based on the Chaikin Money Flow and momentum indicators.
While I'm negative on the energy stocks for the remainder of the year, I do not believe that this will be a final top because of the sector's strong fundamentals. The only short term negative is that the US has plenty of oil in storage. In fact, oil inventories stand well above five year averages. The tightness resides in the gasoline markets because of limited refining capacity. So while gasoline prices could remain high, the price of crude oil could fall creating the top I'm expecting.
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Posted by: Stepdepend | December 20, 2009 at 09:52 AM