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Chart Advisor: The Oil Trade

Investopedia

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Wednesday, May 5th, 2021

1/ Energy sector driven higher by Oil’s surge 

2/ Is now the time for investors to go exploring? 

3/ Example analysis: NOG 

4/ The bottom line

1/ Energy Sector Driven Higher by Oil’s Surge 

The Dow Jones Industrial Average (DJI) notched a brand-new high today while other broad-market indicators failed to do so. Though investors have been showing a preference for blue-chip stocks, the principal driver behind the divergent moves between this index and the others, is energy sector stocks.  

The chart below features State Street’s Energy Sector ETF (XLE) shown as candlesticks and compares it with line charts of securities that represent different industries within the sector including US Commodity Funds’ Gasoline ETF (UGA) and its Natural Gas ETF (UNG), the WTI Crude Oil Futures (USOIL), and two more stocks. Arch Resources (ARCH) is used as a proxy for the coal industry, and First Solar (FSLR) for the solar energy industry. The fact that only one of these lines (UGA) is outperforming XLE, says that the energy sector has one or more components within it that are much stronger than the others. 

That’s likely true because investors are looking for a specific thing within the energy sector: an inflation hedge. The most effective inflation hedges are going to be connected to the price of oil, since oil combines both relative strength against the U.S. Dollar and an opportunity to profit from post-pandemic economic growth. 

2/ Is Now the Time for Investors to Go Exploring? 

Within the Energy Sector index, one component that stood out for strong performance today is the Exploration and Production industry. Within that industry, the stock with the largest market cap is Conoco Phillips (COP). The chart below compares the last two weeks price action between COP and Direxion’s Daily S&P Oil & Gas Exploration & Production Bull 2x Shares ETF (GUSH). This leveraged ETF tracks the industry well, but the leverage degrades its performance over long periods, making it better suited for trading time frames of three months or less. The chart shows what a remarkable gain both have made over the past two weeks. 

3/ Example Analysis: NOG 

Within the Exploration and Production industry, the best possibility for growth will be found in small-cap stocks that have begun to turn the corner on their business prospects. Consider the company in the chart below, Northern Oil and Gas (NOG), an investment company that looks for oil and gas properties located in the premier basins of the lower-48 United States.  

The stock’s share price has struggled for most of the past 18 months, but some of the company’s key fundamentals (see the left panel in the chart below) are trending the right direction for a turnaround.  Meanwhile, the price of the stock has jumped over twenty percent in the past two weeks as the company’s quarterly earnings report approaches. If the company beats estimates, the share price may sell off for a short while but would climb strongly thereafter if the price of oil continues higher on investors’ inflation fears.

4/ The Bottom Line 

While lackluster trading in the major indexes held stocks in a tight range, the energy sector surged higher driven by inflation fears. Investors seem to be showing a particular interest in the exploration and production segment of the sector. 

Originally posted on 5th May, 2021

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