Crude Drug Dealing (XBI,XLE)
Hang on tight as we whiz you through a mélange of charts, numbers and full color pictures of our beloved Auntie Mae when she was just a coy little rutabaga.
But first a word of introduction.
The latest geopolitical tension has given a lot of folks the shakes. Nuclear tests on the Korean Peninsula, armadas of US military ships trailed by Russian and Chinese watercraft, Russian warships tailed by British frigates, mothers exploding in Afghanistan, airstrikes and sarin gas in Syria, French elections, upcoming British elections and all the ongoing hullaballoo in the Middle East’s Gulf States, have both put the world on edge and… had a genuinely salutary effect on the price of oil.
Crude traders can always find solace when the sabres start to rattle.
Oil likes a good war. Especially when it could embroil Saudi Arabia, Iraq, Iran and who knows else, and lift the price of crude out of a multi-year slump.
Here’s a chart of the United States Oil Fund (NYSE:USO), a proxy for NYMEX Crude, since its last highs, posted three years back.
At first blush, the picture looks exceedingly negative. A decline of some 75% peak-to-trough is hard to apply a lipstick to and cozy up with before a fire.
That said, on closer inspection we see a great deal of technical evidence that a bottom is in place and a significant turn higher could be imminent.
- To begin, consider the pattern of three fan lines lower from the June, 2014 top (in red), a very reliable indication that the three year oil bear has come to an end.
- Volume expansion over the period is also a positive sign (in black). It demonstrates that USO shares have moved en masse out of weaker hands into those with a longer term, bullish outlook.
- Next, we see that both RSI and MACD indicators bottomed (February, 2015) and then began turning higher well before price hit its lows a full year later, in February, 2016. On a weekly chart, this sort of divergence is a reliable sign that the selling has lost its momentum and the bulls are now in charge.
- What remains to be seen is whether the shares can break through resistance at $12.20, a level that has cruelly stifled the hopes of oil bulls for better than sixteen months (in blue).
- Should that line be successfully traversed, we’d very likely see USO on its way toward $20, the upside count for a head and shoulders bottom that also exists on the chart, but that we didn’t configure here because it would have been too damn messy.
The $12.20 resistance line is still some 10% away from current prices, but we’re getting 3% and 4% moves in the sector on regular basis lately, so we don’t believe the wait will necessarily be a long one.
And a potential catalyst for the move will no doubt be next month’s OPEC meeting, at which production cuts will be at the top of the agenda. OPEC needs crude prices in the $60 a barrel range (they’re currently at $51), for a number of reasons. Iraq, for instance, needs to generate funds to pay for its war against ISIS, while the other Middle Eastern member countries have to see a rise in order to justify further investment in the sector.
Saudi Arabia, Iraq, and Kuwait are all on record as supporters of an extension of the cartel’s existing 1.2-million-barrel per day production cut, while Venezuela, now bankrupt and on the verge of a civil war, has committed to the same, but with the most expensive extraction costs in the group, may have to cut production significantly more unless prices rise.
Against the oil sector, whose outlook we find especially pleasing, we now turn to the biotech sector, whose performance over the last six months has been almost a mirror image of oil’s.
The biotech sector leaped close to 50% higher in the wake of President Trump’s victory last November, after having been beaten down mercilessly by predictions of a Clinton win. Clinton made no secret of her antipathy for soaring drug costs and the companies that produced them, and the market reacted in line with the inevitability of legislation that would curb biotech profits and rein in the freewheeling road to riches those companies previously travelled.
But the new President has also made noises in the same direction of late, and as he prides himself on being a cost cutter extraordinaire, we should look for active pressure on the biotech stock sector moving forward. Government is the biggest purchaser of prescription drugs, and the president has insinuated that there may be savings in the vicinity of $300 billion a year from renegotiating existing deals.
A number of salient points here –
- To begin, the five month trendline that supported the move since the election was sundered 10 sessions ago (red line),
- The short term moving average has rolled over, and price appears to be capped beneath it (in blue),
- RSI went sub-waterline a month ago and MACD confirmed the move early last week, indicating a bearish posture is now recommended (green), and
- Fibonacci retracement calculations bring the current retracement down to either $60 or $64.
In other words, near term pressure on the sector appears to be down.
Below is a chart of XBI charted against the energy sector, represented by the Energy Select Sector SPDR ETF (NYSE:XLE), year-to-date.
The divergence is so exaggerated that it begs to be traded, especially given the considerations regarding oil and biotech we’ve outlined above.
We give the trade six months to unfold and expect the gap that currently obtains to close significantly in that time frame.- Content protected for Normandy Executive Lounge, Option Trader Elite, Executive Lounge members only]
Many happy returns,