A New Look at the Chaotic Energy Sector

Many energy companies can't benefit from a weak dollar, which offers a major reason for the fracturing of stock performance through the sector. But clearly, it isn't the only reason. In addition, energy-related equities tend to follow the stock market during periods of high volatility and the underlying commodities during periods of low volatility.

Crude Oil Futures

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Source: eSignal

It took just one selloff day in the energy complex for the boneheaded financial media to declare the end of the crude oil "bubble" and the imminent return to happier days for motorists worldwide. But nothing could be further from the truth. The rally that began five years ago shows no signs of topping out, despite repeated call to the contrary.

Crude oil has doubled in price since last August, but the pattern through the period shows great stability, with a series of pullbacks that have found strong buying interest. Notably, the rally paused below 100 for almost four months before breaking out in late February.

Commodity shakeouts tend to be furious, with prices crashing through support to take out stops and make position holders question their faith. Crude went through one of these volatile periods last week, mainly because the long-side trade got really overcrowded after the 100-buck breakout. But this downturn is unlikely to mark the top for energy complex.

Despite this week's bounce, don't be surprised if crude ultimately breaks 100 and drops to 86, which marked the floor for broad 2007 consolidation pattern. That zone would be a great spot for energy bears to declare victory, and then get their heads handed to them when the instrument shoots back over 100 and into another string of historic highs.

With the stock indices in retreat, energy equities are having a tough time pressing up to new highs, even though crude oil and natural gas are still in rally mode. This is well illustrated in the oil service stocks, which are lagging the commodity markets despite a boom business.

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At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.

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