E&P Stocks Have Come On Strong

We talked about the strength in the exploration and production (E&P) stocks before the corrective action in the market took hold. Now these stocks have snapped back, and they are challenging the prior highs in the index.

We find the strength in these stocks interesting since many traders believe that E&P sector price action can lead the price action in the underlying commodity. In our opinion, the majority of equity traders are looking for the price of oil to roll over and head lower from current levels.

Why wouldn't they? Most traders believe the domestic economy is headed into a recession, and as the largest global consumer of oil, a downturn in the economy would lead to significantly lower demand for crude oil. It seems logical to us. In fact, we ourselves had put forth this theory a few days ago when oil prices were near important support.

So, why are exploration and production stocks headed higher? The most likely reason is the anticipated worldwide slowdown is not happening, and demand for oil remains firm. We believe traders should pay closer attention to these stocks and oil in the coming weeks.

The E&P index has rallied back to the prior highs set in December. The rally comes after a retest of the lower limit of the primary uptrend channel in January. The rally off of the lows has been sharp, and we would expect to see some sort of minor pullback or consolidation develop over the next couple of days. In addition, the group is outperforming the broader XOI energy index on a relative basis.

There is overlap between this group and the natural gas pure plays which have also outperformed the broader energy sector. The liquidity line for the group has held up well and shows us that money has held tight in this sector, in spite of the recent market turmoil and call for lower oil prices. Net highs have also started to expand and show bullish underlying price action in the group.

The strength of the E&P stocks makes us take a hard look at the crude oil sector. Obviously, this group is the most sensitive to the price of crude and it is trying to breakout to new highs. Perhaps crude is not as weak as many traders, including ourselves, believe. A break of support at $85 in oil would probably cause traders to abort the trade in the E&P stocks, but the leading strength from this group is very interesting and may be sending a signal.

SPDR Oil & Gas Exploration & Production ETF

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The ETF for the exploration sector is the SPDR Oil & Gas Exploration & Production ETF (XOP - commentary - Cramer's Take). This ETF has had a sharp run recovering from critical support, just as oil did. This rally has brought the ETF back to resistance at the upper end of the trading range in the $52-$54 level.

We would expect some consolidation here near-term, but this move has been surprising and occurred on increased volume. It has been a real tug of war in this sector of late, but the group has tipped in favor of the bulls. Buy the XOP at current levels or on pullbacks to the $50 level.

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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.