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2006-10-26 :: Oil Breaks Downtrend Line

If you look at the graph above, you can see that oil has broken its downtrend line in a fairly decisive manner.  This downtrend has been in place since July, so this is a fairly important technical event, albeit a short-term indicator.

In terms of what this means for our strategy, we are still overweight energy stocks.  This has treated us quite well this month as the energy bears (principally the hedge funds and momentum investors) have left the market and the value shoppers that are focusing on the long term fundamentals of these cash generators (witness ExxonMobil’s earnings report today).  There is not a direct correlation between the price of oil and the stock prices of companies in the energy sector, but there is a fairly close pattern in the charts.

As the prices of energy companies have been moving up, we’ve been raising our trailing stops.  A few of the stops have hit on the way up as investors have sold taken profits in some of the weaker names.  We’ve been stopped out of Nabors, Encana, and Helix (I think HLX will be a long term winner, but its technicals are not as strong as DrilQuip or Smith International, similar companies).  We want to maintain our overweight position in energy, so we have been reinvesting the proceeds in either Schlumberger or Arch Coal, building a strong position in these two companies.

One of my clients pointed me toward a very interesting interview in last week’s Barrons with one of the premier energy analysts in the country (sorry, I can’t recall his name and the article is in my office).  His view seems to fit pretty well with our energy strategy as he sees that crude oil will bottom in 2007 or potentially 2008, then will march significantly higher as the world comes to realize that oil production has peaked.  His numbers show that the top two oil fields in the world have already peaked, in Saudi Arabia and Kuwait.  The number three field, in Mexico, will peak within the next year or two.  The oil fields run by non-government producers (ExxonMobil, ChevronTexaco, etc) will all peak between 2009 and 2011; the exception to this is the Canadian producers (Suncor, Nexen, etc.) which will not peak until the 2040’s. 

The lessen to learn here is one that long-time readers of my newsletter know:  Canadian producers deserve a higher valuation than other producers because their reserves have a significantly longer life than the rest of the world.

More later!