Stock Exchange: Will Oil Hit $70 Soon?

The Stock Exchange is all about trading. Each week we do the following:

• Discuss an important issue for traders;
• highlight several technical trading methods, including current ideas;
• feature advice from top traders and writers; and,
• provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some ideas, please join in!

Review:

Our previous Stock Exchange considered the ability of stocks to rise on technical metrics despite conflicting fundamental indicators. If you missed it, a glance at your news feed will show that the key points remain relevant.

This Week: Will Oil Hit $70 Soon?

In early 2016, Brent crude traded in the low $30’s per barrel, and it seemed absurd to imagine it could double in price anytime soon, especially considering technological advances (e.g. fracking) and the high supply. But here we are, less than two-years later, with Brent crude hitting new multi-year highs of over $63 per barrel, and many investors wondering how much higher it can go.

Last week it was announced that TransCanada’s keystone pipeline had leaked roughly 5,000 barrels of oil in South Dakota. As a result, the company shut down the pipeline, and then announced they expect flow from the pipeline to the US would be reduced by 85% through the end of November.

This recent Keystone reduction, combined with the production cut agreed to earlier this year by the Organization of the Petroleum Exporting Countries (including Russia), have both put upward pressure on oil prices. However, before anyone starts assuming oil is going much higher from here, be aware that US producers have taken advantage of the recent price rally by increasing US output to a record weekly high of 6.658 million barrels a day according to EIA data. Also, don’t forget Organization of the Petroleum Exporting Countries can also simply increase exports (i.e. there is no guarantee they’ll just keep production cuts in place).

The increase in oil prices, combined with the increase in production by US producers, has created some interesting trading opportunities. For example, despite the fact that many US producers continue to struggle with profitability (considering oil price are so much lower than they were just a few years ago, as shown in our earlier chart), many of them are setting up for continued near-term price gains considering their short-interest is high, and they’re earnings will likely be marginally better than previously expected (more on this later).

Trading Model Performance:

Per reader feedback, we’ve recently started including a table summarizing the performance results for our trading models. The table (below) shows actual client results after commissions and fees (I watch this every day, and now readers can see it as well). We’ll share additional information, including test data, with those interested in investing. For our weekly updates, we use only real-time results.

The results in the table above include all of the positions (10 for Road Runner and Athena, 16 for Holmes, and 20 for Felix), not just the specific stock examples we discuss in the Stock Exchange every week (and sorry Oscar, you have too many individual stocks and trades to be part of this approach). We’ve included six months of data since that is the shortest real-time record we have. All of the models are expected to perform well over longer time periods. Holmes, for example, has returned over 20% in the last eighteen months.

And worth noting, our models tend to have a low correlation with the overall stock market, which can be extremely valuable for diversification and risk management purposes. Further still, when “blended” (see table above) our models deliver very compelling risk-adjusted returns.

Expert Picks From The Models:

This week’s Stock Exchange is being edited by Blue Harbinger. Blue Harbinger is a source for independent investment ideas.

Road Runner: I recently bought shares of ENSCO (ESV) back on November 16^th. Are you familiar with this company?

Blue Harbinger: Yes. ENSCO provides offshore drilling services to the international oil and gas industry. Why did you buy this stock?

RR: As you know, I like to buy stocks that are at the bottom of a rising channel. And based on the following chart, you can see why I bought ENSCO.

BH: Interesting pick. Are you aware this company’s net income has been negative all three quarters this year, and its short interest is over 16%? Also, its price is highly correlated with the price of oil, and this is essentially why it has been struggling to be profitable since 2014 (back when oil prices were much higher). Here is a look at the FastGraph.

RR: That information is interesting, but my typical holding period is about 4-weeks. I’ll be in and out of this stock before the company’s next quarterly earnings announcement.

BH: Based on the recent uptick in oil prices, and the impact it’ll likely have on this company’s profits, I am interested to see how this stock moves in the coming weeks. Thanks for this idea Road Runner.

RR: My pleasure. How about you, Holmes. What have you got this week?

Holmes: I have no picks this week. And when I don’t see anything, I don’t force anything. How about you, Athena—what do you like this week?

Athena: This week I like SM Energy (SM). It’s an exploration and production company.

BH: I’m familiar with this company. They explore for, and produce, crude oil, natural gas, and natural gas liquids, onshore, in North America. Why do you like SM Energy, Athena?

Athena: As you know, I am a momentum trader, and my typical holding period is about 1-month. Based on the following chart, SM Energy has a lot of upside price potential.

BH: This is another interesting pick. Similar to Ensco, SM Energy is highly sensitive to energy prices, oil in particular. It also has a high level of short-interest—recently roughly 19% of the shares outstanding were sold short. And it’s not surprising considering SM hasn’t achieved an annual profit since 2014 (when energy prices were much higher). For your reference, here is a look at the FastGraph.

Athena: Thanks for that information, but I’m a trader, not an investor, and SM looks attractive right now. Why don’t we check back on this pick in about 1-month.

BH: Deal. What have you got for us this week, Felix?

Felix: This week I am sharing my ranking of the top stocks in the Nasdaq. My top 20 are included in the following table:

BH: Thanks for sharing that info, Felix. Based on the companies on your list, I can imagine you are a momentum trader.

Felix: I am a momentum trader, but I typically hold my positions for about 66 weeks—which is much longer than the other models. I exit when my price target is hit, and I use stops and macro considerations to control risks.

BH: Based on your list, it seems you really like semiconductor chip companies, including Nvidia (NVDA), Micron (MU) and Broadcom (AVGO). I actually like these companies too, but my time frame is even longer than yours because I know this industry is cyclical and volatile, but it also has tremendous long-term growth potential.

I also see you like three of the four “FANG” stocks. In particular, you’ve included Netflix (NFLX), Amazon (AMZN) and Facebook (FB) in your top 20. I recognize Amazon is an absolute juggernaut, and Facebook continues to blow me away with its mobile advertising, but I’ve personally never really understood the excitement about Netflix. But I do know a lot of people swear by their love of Netflix. Thanks for sharing this information. And what about you Oscar—what do you like this week?

Oscar: This week I’m sharing my favorite ETFs from our most comprehensive and diverse set of ETFs, as shown in the following table. Do you see any on the list that are interesting to you?

BH: The US Oil Fund ETF (USO) stands out to me because we were discussing the oil market dynamics earlier. It makes some sense to me that you’d rank it highly. You are into momentum trades, correct Oscar?

Oscar: Correct. I Use ETFs, I typically hold for about 6-weeks at a time before I rotate into a new sector, and I use stops to manage risks.

Conclusion:

Decreased output from non-US producers has contributed to rising oil prices. US producers have been taking advantage of higher prices by increasing their own production. We may see earnings expectations eclipsed by US energy companies due to the current supply and demand environment. Potentially adding to the momentum, a reduction in the high level of short-interest among many energy companies could help drive stock prices higher. Whether increased domestic production prevents energy prices from rising significantly higher is yet to be determined. However, the changing market environment has already created some attractive trading opportunities.

Stock Exchange Character Guide:

Background On The Stock Exchange:

Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check out Background on the Stock Exchange for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates:

Readers are welcome to suggest individual stocks and/or ETFs to be added to our model lists. We keep a running list of all securities our readers recommend, and we share the results within this weekly “Stock Exchange” series when feasible. Send your ideas to “etf at newarc dot com.” Also, we will share additional information about the models, including test data, with those interested in investing. Suggestions and comments about this weekly “Stock Exchange” report are welcome.