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Oil Stocks: How to Play the Crater in Oil Prices

When oil prices head south, it's time to fill up the ol' rig

At the close of the market on Monday, West Texas Intermediate Crude was selling at $41.88 per barrel. But the rout in oil prices took on a new wrinkle as prices crashed below $40 a barrel for the first time since 2009.

Oil Stocks: How to Play the Crater in Oil Prices

WTI crude oil futures took a dive of more than 3%, falling to $39 a barrel on Friday. That drop comes after the U.S. Energy Information Administration showed a build up in crude inventories against limited demand last week.

That, of course, fueled the bearishness on oil oversupply right now, leading to what is turning out to be the worst weekly losing streak for oil prices since 1986, and oil is now down 35% from its highs.

But don’t turn your back on oil so quick, there’s opportunity to be had here.

To the Charts!

Now, I generally don’t use technical analysis, but when it comes to gold and oil prices, I find charts can be instructive and supplemental to the fundamentals.

Courtesy of Decision Point and StockCharts.com, we see that oil prices burst through support in the mid-to-low $40’s, and the next support is at $35.

Click to Enlarge
Source: Stockcharts.com

I think it is entirely possible we will see that price.

There’s another aspect of this chart that is disturbing. The Price-Momentum Oscillator, a proprietary indicator which appears under the price chart, has topped below the zero line and by now has fallen below its moving average. This is really bad, as it suggests an imminent decline.

Oil Prices Will Rise Again

So why are oil prices so low? It comes down to supply and demand:

The U.S. has doubled its production since 2009, and that extra output has to go somewhere. Meanwhile, Canada and Iraq are producing massive amounts of oil, as well as Russia, Saudi Arabia, Nigeria and Algeria. In other words, the markets are awash in the black stuff, and demand is weak because of Europe and China may be worse than everyone thought, thanks to the yuan devaluation. And when supply exceeds demand, prices fall.

Now we know the situation, so how do we profit or adjust our investing strategy?

From an investment standpoint, recognize that oil will always be a necessity, and supply and demand will always fluctuate. Back in the late 1990’s, crude oil fell to an impossible low of near $10 per barrel. People thought it was the end of the world for energy, yet if you bought stock in any energy-related security back then, you’d have made a fortune.

With that said, oil prices are not going to stay at $40 forever. It may even move lower, but at some point it is going to go back to at least $60. So you have an opportunity to scale into the top energy names now, and to scale in more if oil prices keeps falling.

That means any of the big producer oil stocks like Exxon Mobil (XOM), Chevron (CVX), ConocoPhillips (COP), or any of the big oil service names like Schlumberger (SLB), Kinder Morgan (KMI) or Williams Companies (WMB).

Likewise, you could just buy the Energy Select Sector SPDR ETF (XLE) which has all those oil stocks and more. In fact, the ten Big Oil stocks make up 61% of the fund.

Now, should oil prices fall below $20, then buy up all the oil stocks you can. Get overweight in energy. Sell off anything you may be too exposed to now. Sell off losers and harvest the capital losses, because this is likely to be a once-in-twenty-years kind of oil crash, just like the crash we had in the late 90’s.

Bottom Line

When it comes to trading, oil can cause some serious heartburn. If you want to get short, you have many options: DB Crude Oil Double Short ETN (DTO) tracks 200% of the inverse daily performance of the Deutsche Bank Liquid Commodity Index, for instance. A less aggressive move is to buy the DB Crude Oil Short ETN (SZO) which mirrors the index.

But you can get a bit more focus on WTI Crude by buying the ProShares Ultrashort Bloomberg Crude Oil ETF (SCO), which tracks 200% of the inverse performance of the WTI Crude Oil Subindex.

If you want to go long, there’s the simplest option of the United States Oil Fund (USO). You can get more aggressive with ProShares Ultra DJ-UBS Crude Oil ETF (UCO) which tracks twice the return of Brent Crude. And if you really want to go crazy, the VelocityShares 3x Long Crude Oil ETN (UWTI) gives you 3 times the WTI Index’s returns.

At any rate, it’s likely to be another couple of decades before we see oil go for the bargain it’s currently at.

Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com. As of this writing, Lawrence Meyers was long XLE. 

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Article printed from InvestorPlace Media, https://investorplace.com/2015/08/oil-prices-fallen-cant-get/.

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