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Trading the Undervalued Energy Sector

NEW YORK ( TheStreet) -- If the Federal Open Market Committee announces additional quantitative easing, known as QE3, Wednesday afternoon, the energy sector should benefit.

Investors could view QE3 as the catalyst that will help bring the economy out of the summer doldrums. With stronger economic growth comes demand for energy, with improved consumer confidence comes increased demand for gasoline.

On Tuesday, we learned that the Conference Board Consumer Confidence Index rose to a better-than-expected reading of 65.9 in July. While this is a positive, this measure of confidence is well below 90 to 120 that is considered the neutral range for this economic series.

One way to participate in potential gains for energy and oil companies is through the Energy Select Sector SPDR Fund (XLE), which includes 45 stocks that explore, find, refine and market energy products around the world. Energy stocks can fuel economic growth in the global economy.

The energy sector also provides a platform for speculators looking to gain from the rising price of crude oil. Crude oil prices are also influenced by stress in the Middle East, particularly Iran. Here in the U.S., hurricane season just ended its second month, and August and September should be more active. Crude oil prices will likely rise if a hurricane moves into the Gulf of Mexico and causes supply disruptions.

Here's how to capture gains in the Energy SPDR using my "buy and trade" strategy. The weekly chart shows how XLE tracked the bursting of the crude oil bubble and then its recovery. XLE declined 59.1% from a high of $91.42 in May 2008 to $37.40 into March 2009. The rally from that March low into the April 2011 high at $80.97 was a gain of 116.5% on hopes of an economic recovery.

Notice how the 200-week simple moving average has been a magnet since October 2009. The weekly chart remains positive this week with a Friday close above the five-week modified moving average at $67.80.


Source: Thomson Reuters

The daily chart shows that XLE moved sideways to down on lower highs since the end of March 2011. This is similar to the pattern I discussed on Tuesday for the Materials Select Sector SPDR Fund (XLB) in Trading the Undervalued Basic Materials Sector. Like XLB, XLE has moved sideways to down right through QE2 and Operation Twist. This is another warning that Federal Reserve policy has not achieved the desired results of an improving economy.

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