Based on the October 7th, 2013 Oil Investment Update
Looking at the chart of crude oil from today's point of view, we can say that the first week of a new month and a new quarter was quite good for oil bulls. Although we saw a drop below the August low and the 38.2% Fibonacci retracement level, the buyers didn't give up and stopped further declines, which resulted in an increase to a weekly high of $104.38. In the previous week, light crude gained 0.87% and closed higher for a first time in four weeks. Earlier this week, oil bulls managed to stop sellers and defend the 38.2% Fibonacci retracement level once again, which resulted in a pullback to over $104.
And what did happen with the oil stocks at the same time? They closed lower for a first time in five weeks. Does it mean that they become weaker in relation to crude oil? How does the relationship between light crude and the oil stocks look like? Before we try to answer these questions, let's take a look at the NYSE Arca Oil Index (XOI) charts to find out what the current situation in the oil stock market is. Let's start with a look at the monthly chart of light crude (charts courtesy by http://stockcharts.com).
In our previous essay on oil stocks we wrote:
The XOI not only broke above the July top, but it also broke above the May 2011 high. If the buyers hold the oil index above 1,400 today, this will be the highest monthly close since June 2008.
Although oil bulls didn't manage to hold the XOI above 1,400, we saw the highest monthly close since April 2011. Additionally, the XOI is still above the previously-broken long-term declining resistance line based on the 2008 and 2011 highs and the breakout hasn't been invalidated. The oil index also remains in the range of the rising trend channel.
Taking these observations into account, the situation is still bullish.
To see this more clearly, let's zoom in on our picture and move on to the weekly chart.
Quoting from our previous essay on oil stocks:
(...) the XOI is still close to the May top. (...) we should carefully keep an eye on the oil index. The proximity of the above resistance levelmay encourage oil bears to go short and trigger a correction. In this case, the first support will be around 1,400.
In the previous week we saw such price action and the XOI dropped to a weekly low at 1,394. However, this deterioration was only temporary and the oil stock index closed the whole week above 1,400 once again.
In spite of this rebound, the situation has deteriorated since the beginning of this week. Oil stocks dropped below 1,400 and moved closer to the medium-term support line (marked in black), which is also the lower border of the rising wedge. However, the medium-term uptrend is not currently threatened.
At this point, we'll focus on the relationship between light crude and the oil stocks.
When we take a look at the above charts and compare the price action in both cases, it seems that oil stocks were weaker, because they closed lower for a first time in five weeks (at the same time, light crude closed higher for a first time in four weeks). However, when we take a closer look at the situation in both cases, we notice that this weakness in oil stocks was only superficial. Despite the recent declines, they still remain above the medium-term support line. Meanwhile, crude oil is still trading below its medium-term rising support/resistance line.
Now, let's turn to the daily chart.
On the above chart, we see that the situation didn't change much in the previous week.
However, yesterday we saw a sharp decline which pushed the XOI not only below 1,400, but also below the declining resistance/support line based on the May and July highs. Please note that despite this drop, the breakdown is not confirmed at the moment.
The nearest support is the 38.2% Fibonacci retracement level based on the entire June-September rally (around 1,375). The second one is a support zone based on the Aug. 27 and Aug. 30 lows (1,361-1,364), and a further one based on the Aug. 21 bottom and the 61.8% retracement level (1,338-1,339).
Now, let's comment on the relationship between the WTI and the XOI in the short term. In the previous week, we saw similar price action in light crude and the oil stocks. Last Monday there were declines, however, in case of crude oil the downward move was stronger and took it to a new monthly low. Last Wednesday, we saw a sharp rebound in both cases and the rest of the week looked similar. Nevertheless, this week's price action is totally different in both cases. On Monday, light crude tested the strength of the 38.2% Fibonacci retracement level once again and rebounded, which resulted in a pullback to the previously-broken rising medium-term support/resistance line. At the same time oil stocks dropped below important support levels. Does it mean that they are weaker in relation to crude oil? Not really. Please note that despite yesterday's sharp decline oil stocks didn't even reach the 38.2% Fibonacci retracement level based on the June-September rally. Meanwhile, crude oil tested this level several times.
Summing up, from the long-, medium- and short-term perspectives the outlook for oil stocks remains bullish and the uptrend is not threatened at the moment. Taking into account the relationship between light crude and the oil stock index in the previous week and earlier this week, we can conclude that the oil stocks still remain stronger in relation to crude oil, even though they declined below 1,400 and the declining resistance/support line based on the May and July highs.
Those of you who plan to take long positions in the crude oil sector might want to consider choosing oil stocks instead of crude oil itself as it seems to have greater upside potential at this moment.