Energy Could Be Ready to Rally Again

Crude oil may be bottoming out here and setting up for a strong 2006 rally. Will oil and gas stocks recover along with crude prices?

Energy stocks topped out in September, after Katrina spiked prices to all-time highs. However, the group was unable to sustain those levels and fell to earth in a persistent correction that's now in its 12th week. As I pointed out on Monday, there's good reason to believe the selloff is at or near sustainable lows.

Oil and gas equities performed unevenly last summer, with some stocks charging to new highs while others got stuck in the mud. In particular, oil service stocks pressed marginally higher but never enjoyed the strong rally that most of us expected after crude oil broke resistance in the low $60s.

Diamond Offshore Drilling (DO - commentary - Cramer's Take) offers a good example of this limp response to bullish developments in the energy pits. After hitting $57 last June, it has been wobbling around in a seesaw pattern that shows minor gains and considerable danger. Despite hitting a marginal new high, upside momentum has deteriorated significantly and now suggests a broad topping formation.

On a positive note, accumulation has declined minimally since the October peak. This indicates that long-term investors still believe the stock is in a secular bull market that has several more years to run. But the next rally isn't showing up on this stock's chart yet, or the companion charts of most oil service stocks.

Valero Energy (VLO - commentary - Cramer's Take) is one of the new wave of oil refining issues that trade more like tech stocks than energy companies. It printed an all-time high after Katrina, because its physical location and efficient processes put it in the perfect position to capitalize on the damage in the Gulf states.

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Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by TheStreet.com.

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