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Iraq Violence Contributes to Ongoing Strength in Oil, Energy Stocks

NEW YORK (TheStreet) -- As tension in the Middle East -- including the latest fighting in Iraq, has risen this year, oil prices have spiked higher, leading to a strong, lengthy bull run in the Energy Select Sector SPDR (XLE), an exchange-traded fund that tracks the energy sector.

The strength in oil has led to price leadership in companies such as Exxon Mobil (XOM), Chevron (CVX), Schlumberger (SLB), ConocoPhillips (COP), EOG Resources (EOG), and Occidental Petroleum (OXY).

XOM Chart
XOM data by YCharts

Brent oil, represented by United States Brent Oil Fund (BNO), has been the catalyst for energy sector leadership.

Brent futures broke to more than $115 in last week's trade for the first time in 2014. Concerns of supply disruptions in Iraq supported oil prices. Many Iraqis were killed during a battle in the provincial capital Baquba.

The civil war in Iraq shows no sign of ending soon as the Sunni insurgents continue to gain ground.

XLE Chart
XLE data by YCharts

The correlation between Brent oil and the energy sector is very strong, meaning the two assets rise and fall in price together.

Studying the past five years of price data, there is a clear trend that emerges between when oil prices spike and how energy stocks react.

The overall price of oil does not seem to matter. Rather, it's the percentage price change of oil. For example, when oil futures spiked 10% higher over the past month, energy stocks followed for a 10% increase of their own.

Similarly, the length of time oil futures spend above $115 does not matter either for prices of energy companies. If oil futures spiked above $120 in the next week, energy stocks would share in that strength, but if the futures traded sideways, then energy stocks would likely consolidate as well.

The relationship exists because the stock market it forward-looking. U.S. gas prices tend to lag the movement in oil futures, so tangible profits will probably not be generated by energy companies until the end of the quarter.

The rise in oil futures, however, signals that those revenues will eventually come, and thus leads to strength in energy stocks.

The run-up of energy stocks this year has been impressive, but oil futures must continue to push higher for the energy sector to outperform the S&P 500, as tracked by the SPDR S&P 500 (SPY) ETF.

If $115 is the top for Brent oil futures, and oil prices subsequently decline for the rest of the year, it would mean an end to the energy sector bull market.

At the time of publication, the author had no position in any of the funds mentioned.

Follow @macroinsights

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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