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Energy Vs. Financials

Below I have cut/paste an article written by noted analyst Scott Rothbert from The Edge. He gives his opinion on the current retreat in energy stocks vis-a-vis financial stocks and oil itself. Energy stocks have corrected much more than the price of oil and he sees that situation correcting itself when the current rush to buy financials ends.

His view mirrors my own, but I thought you’d like to read someone else’s perspective on this issue.

Mark

PS – please note that I’ve added a couple of clarifying comments to his writing and you will find those in blue italics below.

The Edge

Crude/Oil Service Divergence
7/24/2008 9:02 AM EDT

QuickTake
Bullish SLB
Update OIH RIG HAL


The cuffs don’t match the collars for crude prices and oil service stock prices.
Eventually, when the financials end their rebound, money will flow right back to oil service and material stocks.

There is a major disconnect between the price of crude oil and the price of oil service company shares. I call this a “cuffs don’t match the collars” condition. Let’s look at two charts. The first chart is of Nymex sweet crude for the past 12 months:

Click here for larger image.
Source: Oilnergy.com

Compare that chart to the Oil Services HOLDRs (OIH), an ETF of oil service companies.

OIH One-Year (Amex)
Oil Services HOLDRs
Click here for larger image.
Source: Yahoo! Finance

The top three holdings in the OIH are Transocean (RIG) for 16.07%, Schlumberger (SLB) for 10.37% and Halliburton (HAL) for 9.97%.

Through yesterday’s close, when the OIH closed at 194.15, that ETF rose about 3% (over the last year) on a price basis while crude oil rose by over 70% (over the last year). These types of phenomena exist when you have leveraged, fast-money traders move in and out of stocks with no regard for valuation or fundamentals. That is good for investors who are in for the long run, but they unfortunately have to feel the pain of the short-term volatility.

Speaking of volatility, the CBOE Crude Oil Volatility Index (OVX) stands at a whopping 51.54. That makes the CBOE Nasdaq Volatility Index (VXN), which stands at 27.39, look like a docile mollusk.

Either crude oil will have to decline by 50% or more, or the oil service stocks will rise once again. I am of the strong belief that we will see the OIH and its constituent stocks rise 20% or more before we see crude oil back to the $70 or $80 range. (The level of and has not erased the imbalance between supply and demand).

As long as the energy destruction/financial stock rebound trade maintains its momentum, however, the “cuffs not matching the collars” condition will exist. Eventually, when the financials end their meteoric rebound, money will flow right back to oil service and material stocks.

Position: Long SLB