Oil Prices Put SWN in Play

The market had a tough day Wednesday, but if traders were exposed to commodities, it certainly helped lessen the pain. The commodities market surged higher, led by crude oil, as it hit $100 intraday after reports of geopolitical turmoil in Nigeria.

The $100 level for crude oil appears to be a key psychological level, and we believe that once this level is breached, traders will move much more aggressively into the energy sector.

As traders, what is catching our attention is the sentiment toward crude. Oil is surging higher, but we still sense a lot of resistance to the move. It seems to us that many analysts simply cannot comprehend oil over $100 a barrel. The prevailing wisdom has many analysts and traders believing that $100 oil is some sort of mistake that will be corrected shortly.

Maybe this is true, but our experience tells us that if a trading vehicle, such as oil, trends strongly, breaks resistance levels and comes back quickly after minor corrective action, then maybe there's something behind the move, and even higher prices are likely. We wouldn't be surprised to see oil break out and make a move toward $120.

We believe that a breakout over $100 in crude oil will cause capitulation from traders, and the liquidity flow toward the energy sector will accelerate. This effect may be exasperated by the weak and narrow nature of the market at this time.

If crude breaks out, then there aren't many groups that will look more attractive than the energy sector. "Long only" money managers will be forced to put more money to work in the sector in order to make any money in the first quarter.

Traders should continue to get long the exploration and production, and oil service stocks. The "crack spread" between oil and gas remains tight so we would avoid the refiners for now. We also believe that natural gas could make an attempt to break out over the $8.50 level. A breakout in natural gas would have us moving aggressively toward that sector.

There are many ways to play continued strength in the oil sector. We like the exploration companies, especially those that have exposure to nontraditional sources of crude. This would include products such as tar sands and shale. Companies with oil or oil equivalent reserves in the ground are simply worth more as the price of oil increases.

Southwestern Energy

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Within that space, Southwestern Energy (SWN - commentary - Cramer's Take) is a strong technical configuration that has exposure to shale oil and natural gas. This stock has recently broken out to new highs on strong volume. The volume indicates strong demand for the stock.

A new high in price is a bullish sign, as it also indicates buyers are in control. The consolidation preceding this rally suggests a move to the mid-$60s is likely near term. A move back below the $52 level would negate the recent strength and suggest a correction is in order.

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At the time of publication, John Hughes and Scott Maragioglio had no positions in the stocks mentioned. Hughes and Maragioglio co-founded Epiphany Equity Research, which has developed and utilizes proprietary tools to identify and track liquidity changes in the market indices and sectors. Hughes advises numerous asset managers, hedge funds and institutions managing in excess of $30 billion. Maragioglio is a member of the market technicians association (MTA) as well as The American Association of Professional Technical Analysts (AAPTA) and holds a Chartered Market Technician (CMT) designation. Maragioglio has also served on the board of directors of the AAPTA.