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Oil stocks are again testing important support stretching back 3 decades -- how long will it continue to hold?

About a month ago, we pointed out the approaching potential support in the beleaguered oil stocks. Specifically, the NYSE ARCA Oil & Gas Index (XOI) was hitting a cluster of meaningful support levels near the 1140 mark including,

The March 27 Initial Low ~1147

The November Post-Election Launch Point ~1125-1142

The 38.2% Fibonacci Retracement of the January-December 2016 Rally ~1139

We surmised that these levels alone should be enough to spark at least a mean-reversion bounce in oil stocks which had lagged badly since the beginning of the year. But if that weren’t enough, the piece de resistance (or, piece de support??) was the presence of the XOI’s lifetime Up trendline which was intersecting the same 1140-ish area. Considering the trendline had been in place for 3 decades, it was a boost of confidence that the level should in fact hold for the time being.

Well, outside of a 1-day “fakedown” on May 4, the level has indeed held. However, any meaningful mean-reversion bounce has been elusive. Outside of an initial 4% pop in the days following the previous post, the XOI has had trouble getting off of the mat. Today, we find it once again testing its 30-year “line in the sand” as we first coined the trendline over a year ago.

Here is a closer look at the recent action in the XOI vis-a-vis the trendline. Notice how, despite the age of the trendline, and the fact that it suffered a large false breakdown in early 2016, it continues to serve as the defining factor in directing the XOI price. Close to double digit times over the past few years, we saw the trendline hold precisely as support for the XOI. Oil bulls need it to do so again right now.

So do we think it will continue to hold? It remains possible, as we stated in the April post, that this action is still part of a retracement test of the post-election rally. If so, oil stocks should hold the trendline again and resume their leadership that they displayed throughout 2016.

However, there are a few aspects of the recent action that we don’t like, as far as the prospects go for oil stocks. First off, the repeated testing of the trendline is bound to begin wearing it down, rendering it weaker and weaker with each test.

Especially damaging is the false breakdown on May 4. While a false breakdown can be a powerfully bullish force, the positive ramifications are typically manifested immediately following. In this case, the “fakedown” provided very little lift off of the trendline. This is further evidence of the weakening of the trendline. Recent tests of the line have resulted in relatively meager bounces off.

Furthermore, this performance by oil stocks, and its present proximity to the long-term trendline, has come about despite a very positive environment overall for stocks. With major averages sticking near all-time highs, the fact that oil stocks are plumbing 52-week lows is very discouraging. Perhaps oil stocks will be a safe haven of sorts and a destination for rotated money should the general stock market top and begin to correct. That is really a reach, though.

More likely, oil stocks are in a precarious spot -- and made more precarious by the fact that the broad market has precious margin for error here at nose-bleed levels. It isn’t that the broad market looks that vulnerable, but oil stocks may need the general market to continue its inexorable rise just to keep them afloat. That may be too tall of a task.

Otherwise, oil stocks may need oil itself to embark on a strong advance. However, the trouble there too is the fact that crude oil has had a pretty good run over the past 15 months. Recent action has put a damper on that rally, however, and the commodity looks susceptible to at least a deeper retracement of the post-2016 rally. If that transpires, it will obviously be a head wind for oil stocks.

Lastly, one vehicle in which to take advantage of rallies in oil stocks is the Energy SPDR ETF, ticker XLE. Here too, we see evidence of softness in breaching what was, in our view, a decent confluence of support near the 67.50 level. Sure, prices can reclaim that level. But the breakdown opens an easier path lower in the XLE.

The bottom line is that the inability of oil stocks to sustain any meaningful upside despite favorable environments in the broader equity market and in crude oil should be a serious concern for oil stock bulls. Furthermore, the potential springboard in the 30-year Up trendline has not proven very springy of late. At this point, more so than at other recent tests of the trendline, the XOI looks increasingly vulnerable to breaking down below the “line in the sand”.

Members of The Lyons Share get tons of these charts and research every day. If you’re not a member, now is the perfect time to join us as we have extended our Spring Sale through Memorial Day.

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Exxon Mobil is testing the underside of its 30-year Up trendline, which it broke one year ago.

Since we started our Chart Of The Day (ChOTD) series on Twitter about 3 years ago, folks have been asking us to post more and more charts. For the sake of education/sharing/community, we would love to publish all the charts that we find compelling on a daily basis. However, the reality is that time constraints prevent us from being able to share more. Thus, we have really made a concerted effort to post at least a ChOTD each day (I believe we’ve missed just one day in the past 2 years).

However, one low-maintenance way we have been able to share a few additional charts each week is through the highlighting of one the oldest and most basic of all technical analysis tools -- the trendline. A trendline connects several key points on a chart (e.g., a series of tops or bottoms) and, as its name implies, traces out the current trend in a price plot. When connecting lows, the trendline can serve as support and when connecting highs, it can serve as resistance.

Trendlines can be found in almost any chart, if one looks hard enough. However, the best practice is to focus on those trendlines that connect multiple major junctures without materially violating the trendline. In other words, be honest with the trendlines you are drawing. If your goal is truthful price information, there is no reason whatsoever to cheat a trendline in order to fit your bias. In that vein, in our feature “Trendline Wednesday”, we offer a handful of the best fitting, most important and, often times, under-the-radar trendlines in the financial markets.

One of our all-time favorite trendlines can be found on the chart of one of the largest stocks in the world: Exxon Mobil (XOM). We first pointed it out over a year ago and have continued to monitor it since. The line (on a logarithmic chart) stems from the intraday low made during the crash of 1987. From there, it connects (and has supported) major lows formed in 1994, 2010 and early 2015.

Now some will call this pure luck or randomness. We would respectfully disagree as the odds of these near-precision touches randomly occurring over a 3-decade span would be astronomically long.

After holding basically to the penny in March of 2015 (what luck), the trendline was finally broken a few months later in June. This break ushered in a 22% drop within months, into the August low. In the subsequent bounce, XOM rallied up to test the underside of the broken post-1987 trendline. As per classical technical analysis, the assumption was that the former support line was now resistance. And indeed, on November 3 of last year, the stock formed its high for the post-August rally at the trendline -- again, basically to the penny. That is quite a bit of random luck.

This chart gives a closer look at the action around the trendline during the past 2 years.

What are the practical ramifications here? XOM closed today at 90.72. The post-1987 trendline is crossing around the 92-even level at the moment. Therefore, should prices climb just a little bit more in the near-future, the stock could encounter another test of the underside of the trendline. The assumption, again, is that the trendline will act as resistance. This may also have an impact on the rally in energy/oil stocks -- and even possibly the broader market given the market cap of XOM.

Of course, should prices break above, and hold above, the trendline, that could provide a floor under the stock and allow for a steeper trajectory of ascent. Either way, we will take cues from the trendline, again -- in hopes of getting “lucky”, again.

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More from Dana Lyons, JLFMI and My401kPro.

A key index of oil stocks has moved back above its (temporarily broken) 30-year up trendline...for now.

“If the XOI can reclaim that broken trendline, perhaps it can once again serve as support for the oil stock index as it did for 30 years. Not to mention, it would look like a compelling “false breakdown”. These factors could serve as a springboard to a major, sustainable rally in oil stocks.” - March 8 post: The Line In The (Oil) Sand

As modern trendlines go, the 30-year up trendline in the NYSE Oil & Gas Index, a.k.a.,  XOI, is among the most prolific (behind perhaps only the decades-long down trendlines in 30-year U.S. treasury yields and the Japanese Nikkei 225.) The uptrend in the XOI (on a log scale) began just after the inception of the index in 1986 and connects the 2003 lows and the lows of last August, September and December. The trendline was finally broken in January, paving the way for an 18% plunge in about 2 weeks.

Subsequently, the XOI bounced back to test the underside of the trendline, prompting our March 8 post. In the post, we suggested that those trying to decipher whether or not oil stocks had bottomed might be well served to simply focus on whether the XOI could reclaim its broken trendline or not. If not, expect continued weakness with potential further new lows. If it was successful in reclaiming the line, then the bullish potential was considerable, as mentioned in the opening paragraph. As of yesterday, it appears as if the XOI has reclaimed its broken 30-year uptrend.

Now does this mean you go all-in oil stocks and forget about them for 5 years? Of course not. For one, we don’t ever recommend leaving any investment unattended without some form of risk controls standing by. Secondly, despite the recovered trendline, there remain some shorter-term challenges for the XOI nearby. Specifically, the index is now testing its post-2014 down trendline, also on a log scale. On top of that is the 200-day moving average and an assortment of key Fibonacci Retracement lines from the key tops over the past few years as shown in this chart.

So the reclaimed 30-year trendline is not a be-all and end-all. It could fall back below the line again as it did last month. Furthermore, the fact that it has broken the line likely means the trendline has been softened up a bit. However, for objectivity’s sake it may be the best decision-maker available for those traders/investors considering jumping (back) into oil stocks -- or those still waiting to cut their losses.

Whatever the case may be, the line is relevant on a 30-year basis so it carries significant weight. At the very least, it provides a clear line in the sand nearby to trade against. And if the XOI decides to remain above that line in the sand, oil bulls may finally get their long awaited recovery.

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More from Dana Lyons, JLFMI and My401kPro.

The Oil Volatility Index convincingly broke below its post-2014 Up trendline today; that could mean less volatility ahead for oil prices.

Volatility indexes have become increasingly accessible and popular in recent years. These are measures of the options market’s expectations for future volatility in the underlying asset. In most markets, the volatility index rises when the underlying falls, indicating an increased expectation of volatility. That’s why these volatility indexes have become known as “fear gauges”. The most well known volatility index is the S&P 500 Volatility Index, better known as the “VIX”. However, there are now volatility indexes covering a wide array of markets, including the oil market. And the Oil Volatility Index, or “OVX”, made a move today that may be sending an important message regarding this currently key asset.

To clarify, the OVX actually tracks volatility expectations on the USO, the United States Oil Fund exchange traded product. However, the effect is the same with regards to the OVX’s relation to oil prices. When oil topped out in June 2014, the OVX established its all-time low since its 2008 inception. Since then, as oil and the USO have been pummeled, the OVX has been in a very clearly defined uptrend. And despite some fits and starts over the past year in the oil market, the OVX has remained relatively sticky in its elevated level, suggesting that market participants have remained steadfastly “fearful”. Today may have signaled the start of a change in that regime.

Why? The OVX dropped exactly 5 points today, or just over 10%. In the process, the index broke the post-2014 Up trendline -- and in decisive fashion. 

Using a logarithmic scale, one can see how the lows in the OVX in June and August 2014, June and November 2015 and earlier this month traced out a very neat Up trendline (FYI, on a linear scale, the post-June 2015 Up trendline was also decisively broken today).

So what does this mean? It means that market participants are, for the first time in years, expecting a lowering of volatility expectations relative to the recent trend. And while we are often tempted to fade what the crowd is thinking, the volatility market often has it right in these situations, i.e., at key junctures or changes in trend.

One example is a post we wrote on March 25 of last year. It highlighted the fact that, while oil prices had recently made a slightly lower low than the January lows, the OVX had held below its prior top, indicating a potentially positive divergence. Similar historical divergences had resolved themselves in higher oil prices and a lower OVX. Indeed, oil prices would immediately rally some 40% before commencing a new down leg.

These OVX signals are not foolproof, however. A case in point -- when oil prices bottomed in February, the OVX did move to a new high instead of diverging. This signal gave us pause in declaring a likely durable oil bottom. However, tops and bottoms will never display unanimity of signals. Thus, we also need to look at tools that may be helpful in determining a change in trend if a top or bottom couldn’t be identified in real-time. That’s where this OVX trendline break may be sending an important message.

I know I have groused about one of our pet peeves, inter-market analysis, on several occasions. Simply put, our view is why try to figure out A by examining B when you can just examine A? In this case, however, at least the OVX is derived from data pertaining to the oil market itself. Thus, our view is that its message is most certainly relevant to the underlying oil prices.

And the message is that the steadily rising uptrend in oil volatility expectations has been snapped. It does not mean that oil prices will go straight up or that the OVX will go straight down. However, it is the first step in establishing a new regime whereby oil volatility is finally more subdued. Often that signals higher prices.

We don’t know for sure if higher prices are in the cards, but if the options market is correct, at least they will be calmer prices.

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“Oil Field Workers” photo by Martin Konopacki Photography (1942).

More from Dana Lyons, JLFMI and My401kPro.

The current test of a 30-year trendline could determine whether or not the bounce in oil stocks is sustainable.

What do all the inquiring minds want to know right now? Is the bounce in energy stocks for real? Analysts, pundits, gurus, oil tycoons and social media macro tourists all have an opinion on whether oil and oil stocks have bottomed and are on their way to boomtown again...or are in the midst of a dead-cat bounce, destined for the dusty plains of new lows. While they’re busy pouring over economic data out of China, storage reports and rig counts, parsing words out of OPEC and handicapping the U.S. presidential race for clues, we wonder, what if it merely comes down to a single line drawn on a chart?

Ah, technical analysis...we can hear the groans, not to mention the “simpleton” and “voodoo” callouts. Whatever. Drawing lines on a chart may have its flaws and drawbacks. But, I know 2 things for sure: 1) it can help objectively define the price at which one is right or, importantly, wrong on a position and 2) it is vastly more accurate than the litany of variables above. Especially if one has the correct line. And we think we have a good one, as it pertains to oil stocks.

Using a log scale chart of the most popular oil stock index, the NYSE Oil & Gas Index, better known as the XOI, we note an up-sloping trendline that has been intact for almost its entire existence. The trendline precisely connects the lows in July 1986, January-March 2009 and August-December 2015. On January 6 (remember that date?), the XOI broke the trendline for the first time, subsequently falling another 15% into the January 20 low (remember that date?).

Since then, the XOI has bounced all the way back and is presently testing that breakdown area.

If the XOI can reclaim that broken trendline, perhaps it can once again serve as support for the oil stock index as it did for 30 years. Not to mention, it would look like a compelling “false breakdown”. These factors could serve as a springboard to a major, sustainable rally in oil stocks.

Of course, should it fail here, it would confirm the January breakdown and further cement the trendline as new found resistance. It would then need to search for a new price catalyst to spark a rally, a difficult prospect when prices are probing 6-year lows.

If you have a difficult time with the concept that prices could have “memory” going back 30 years (btw, ask Exxon Mobil investors what happened once the stock broke its 30-year trendline back in June), well, the XOI is also dealing with some potential resistance levels on a shorter-term basis. Besides the January breakdown point (which occurred at the 30-year trendline), there is a close confluence of Fibonaccii Retracement lines from recent highs, specifically:

the 23.6% Fibonacci Retracement of 2014-2016 decline

the 38.2% Fibonacci Retracement of April-January decline

the 61.8% Fibonacci Retracement of November-January decline

It is not shown on this chart, but the XOI did pull back from this area by more than 4% today. So, whether one thinks of this analysis as voodoo or over-simplified or whatever, there are some chart lines that it just may pay to keep in mind -- literally.

This 30-year line in the sand for oil stocks is one of them.

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More from Dana Lyons, JLFMI and My401kPro.

Despite sharp bounce, energy funds have not yet attracted heavy inflows.

Much of the market debate currently is centered around the question of whether the market has put in a sustainable low, at least for the intermediate-term future. At the center of that debate lie the energy and materials sectors that have been beaten down mercilessly. A solid low in those sectors would certainly bode well for the broader market’s chances of continuing the recent bounce for awhile longer. In addition to some positive price action, one factor perhaps in favor of a continued bounce in the energy sector is the relatively complacent reaction by investors toward the sharp rally over the past few weeks. Despite jumping some 17% off of the recent lows (as measured by the Dow Jones U.S. Oil & Gas Index), investors have been slow to pour money into the sector. From a contrarian basis, this is the kind of skepticism that bulls want to see at the onset of a rally.

One example comes from the Energy Select Sector SPDR ETF, ticker XLE. The XLE has bounced roughly 16% off of its late September low, yet the number of Shares Outstanding in the fund have actually decreased over that time.

Historically, there have been 2 other unique periods in which the XLE rallied more than 10% over the course of 10 days with an attendant drop in its shares outstanding. Those occurred in March-May 2009 and October 2011. Of course, the sector, and the market in general, were emerging from sharp declines at those times. The bottom did prove to be in, however, and the rallies continued on for several more months. 6 months after each of those events, the XLE was higher by 20%-30%. Now, there were a couple false signals in January 2009 that would lead to the marginal new low in March. However, the low was at least close at hand.

Another example of investors’ reluctance to jump aboard the energy rally comes from the Rydex (Guggenheim) family of mutual funds. Here again, we see that, despite near-20% gains in both the Rydex Energy and Rydex Energy Services Funds, the funds’ assets have risen very little.

As the chart shows, the combined assets of the Rydex Energy and Energy Services Funds have climbed a relatively small amount during the rally. Yes, those assets have risen from an all-time low of $27 million on October 1 to $45 million today. However, compared with the yearly high of $100 million in May, the inflows have been paltry.

Now eventually, the sector is going to need to see some inflows. That is how rallies are fueled. However, at the onset, bulls want to see enthusiasm at low levels. As long as there is a healthy amount of skepticism, there are potential eventual buyers on the sidelines. This is the proverbial wall of worry.

This reluctance on the part of investors to pour money into the energy sector does not guarantee the rally will continue. However, if one is bullish, it is a far preferable reaction to a sharp bounce than had the sector seen record inflows.

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