Strangling the Energy Market (UNG, USO, DBC)

One of the most profound moves in the market of late is also one that almost no one is talking about.

It has taken a back seat to a news cycle that’s all-out hairy with terror stories and war stories and potential war stories, so it’s not a surprise, really.

That, coupled with the new highs that the major indexes are posting on a near daily basis, and is it any wonder no one cares or has time to look under the hood and see that the commodities have been chewed up like Robert Shaw in the movie Jaws.

thatsit

We’ll have a look at the commodities chart in a moment, but for now you should know that this is just part of a broader theme that’s unfolding precisely as we’ve predicted for the last several years. It has a number of components, the most prominent of which are –

  • Rising equity prices, particularly in America,
  • Declining prices for fixed income products, particularly U.S. Treasuries,
  • A near abandonment of all other asset classes, including commodities,
  • A strengthening U.S. Dollar, and
  • Inflation, inflation, inflation.

And while it’s true that not all of these sub-themes are in evidence as yet, we remain convinced of their inevitability and staunch that our investment positions remain focused on them.

As to rising equity prices, the near abandonment of other asset classes, and a climbing U.S. Dollar there’s abundant proof that the market is in accord with us.

It’s only vis-à-vis the bond market and inflation that we’re still waiting for the proverbial rubber to envelop the banana, as it were.

smut

The bond market will fall into line of its own accord and in its own time. We can’t be certain of an exact top for that asset class, but it matters little. For those who choose to pay heed, our only advice is to cash in now while the bond going’s good. And for those who require fixed income product as a necessary part of their investment portfolio, we recommend you stay tuned here for a wealth of ideas in the weeks to come.

Back to the Commodities Washout

The chart below is from the Deutsche Bank PowerShares Commodity Index Tracking Fund (NYSE:DBC). But before we look at it, a general word on commodities indexes is in order.

There are a great number of indexes that purport to speak for the vast array of futures that comprise the asset class we call ‘commodities’. But the truth is, they all emphasize one subgroup of items at the expense of another, and will therefore evince vastly different trading patterns depending on issues as divergent as climate, law and war, not to mention seasonal factors, speculative interest and a host of other inputs.

So, one index that’s more heavily weighted toward the softs, for instance, will have a completely different range of movement than one geared toward metals or energy.

That said, we’ve chosen the DBC ETF to be our representative index because we believe it provides a reasonable proportionality between the commodities and also has the advantage of sufficient liquidity, with some $50 million worth of shares exchanging hands on a daily basis.

Let’s get to the chart.

This is the weekly for the last four years –

dbc

  1. Here we see a stock in decline for three and a half years, currently trending only a hair above its previous lows (top black line) and a meager 3% above its all-out bear market bottom at $24.15 (lower black line).
  2. We see two of four moving averages already rolled over and the other, longer-term MAs flattening in preparation for the same (blue box).
  3. The latest highs set in June (also in the blue box), were a clear attempt to break above resistance at the long term (yellow) weekly moving average at $27. That attempt failed. And the subsequent selloff was dramatic, as traders apparently voted against the prospect of a bullish breakout occurring anytime soon.
  4. To cap it off, we see that weekly MACD readings fell below their midway waterline two weeks ago, confirming a similar dive by the RSI at the end of June (red circles), and in so doing, offer a negative immediate outlook for DBC shareholders.

The Skies Darken

And that negativity is also supported by the daily chart.

Look here –

dbcdaily
There’s almost nothing here for the bulls to latch onto.

  1. RSI and MACD are both trending deep below their waterlines (in black), and it would take weeks of sustained bullish action to lift them from their current shark-infested depths.
  2. All the stock’s moving averages are unfurled and trending lower (in blue), and price is below them all, a development indicative of both weakness current and to-come.
  3. To top it off, a decline of a just over one percent in the index would sever support at $24.63 and likely send DBC hurtling toward her next line of support (mentioned above on the weekly chart) at $24.15.

So that’s the lay of the commodity land, eh?

You got it.

But there’s one more detail.

Much of the recent decline in the commodities has been attributable to a selloff in the crude pits. Crude oil has declined from highs set in June of just below $106, down to their recent lows in the $92.60 range. And we believe that’s about where things will remain for that commodity, despite ISIS and the Russia/Ukraine conflict that has many concerned that supply disruptions could send both crude and natural gas prices soaring.

We recognize the validity of such concerns, but we’re now tending toward a position that speaks to price stability in both gas and oil going forward, at least in the near term.

Why?

Because the big Middle Eastern producers, Saudi Arabia, UAE and Kuwait all have the will and ability to respond quickly in the event of a disruption with increased supply, and neither ISIS nor Russia has any intention of sending their current customers looking for new suppliers, a move that would dent both groups’ ability to make war.

With that in mind, we’re urging the sale of near term PUTs and CALLs on both the United States Oil Fund ETF (NYSE:USO) and the United States Natural Gas Fund ETF (NYSE:UNG).

Have a look here –

ung
In both cases, we’re selling at current support and resistance levels, and we’re using the October expiry as a deadline.

It’s a short strangle energy double whammy.

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The Profit Hunter recommends you consider the sale of the following options – the USO October 37 CALLs and 34.50 PUTs, and the UNG October 24 CALLs and 21 PUTs. Prices for the four options are, respectively – $0.32, $0.33, $0.35 and $0.35, producing an immediate credit of $1.35 for each quartet sold.

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The Profit Hunter recommends you consider the sale of the following options – the USO October 37 CALLs and 34.50 PUTs, and the UNG October 24 CALLs and 21 PUTs. Prices for the four options are, respectively – $0.32, $0.33, $0.35 and $0.35, producing an immediate credit of $1.35 for each quartet sold.

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With love of the hunt,

Hugh L. O’Haynew, Senior Analyst, The Profit Hunter

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