It used to be as oil went, so went the oil stocks. For the three years leading up to 2007, this has been the case. As oil prices moved higher or lower, so would the energy stocks.
It's a very simple equation. Rising prices are typically driven by higher demand and less supply. This, in turn, drives demand for all the services and support that go along with pulling more oil out of the ground, maintaining the equipment and the services associated with it.
Demand for the basic commodity spurs the need for everything associated with pulling the black gold out of the ground. There is increased drilling and increased demand for oil equipment, the need for shipping increases, replacement parts are in demand and exploration activities rise as well.
Over the first five months of the year, we have seen a disconnect between the price of oil and the price of oil stocks. From time to time, one will outperform the other, but this usually occurs as they are both moving up or down with one simply edging out a lead over the other.
Amex Oil Index
Over the past eight months, except for a sharp drop in January, the price of crude oil has remained pretty much the same. Yet during this same time, energy stocks as a broad group have been moving higher. The Amex Oil Index (XOI) has rallied about 28% since the January lows. That's an impressive rally. When you break out the specific sectors, you will find certain subsectors that have done even better, such as the refining space.
, for example, has rallied more than 50% from the January lows.
This occurs because it is not just rising prices, but firm prices for oil that support the underlying companies that are in the oil industry. As long as oil companies can make money at oil's current price and expect it to stay there, they will invest in the infrastructure and services needed to produce that oil. This directly translates to the bottom line of the oil and oil service companies.
One area that has not participated to a large degree in the recent strength due to oil's flat performance is the exploration companies. This appears to be changing, and this subsector is starting to heat up.
is an energy exploration company that is reflective of this change, and I am highlighting it as a way to benefit from the continuing sector strength and positive technical improvements affecting the exploration space.
The breadth line for the energy exploration group has pushed out to a new high, indicating liquidity is flowing to these stocks. Anadarko is emerging from a multimonth base and should continue to catch up to the rest of this sector. The volume has been increasing into the recent strength, also suggesting demand is growing. We expect the stock to continue higher toward the mid to upper 50s.
At the time of publication, John Hughes had no positions in the stocks mentioned.
Hughes began his career at the NYSE in 1989 followed by twelve years running the technical analysis department and co-managing a hedge fund for a New York based brokerage firm. In 2001, John Hughes co-founded Epiphany Equity Research, which has developed and utilizes proprietary tools to identify and track liquidity changes in the market indexes and sectors. Mr. Hughes advises numerous asset managers, hedge funds and institutions managing in excess of $30 billion.