Archive for energy
As I discussed in February, the U.S. energy sector is a preferred position compared to the Canadian energy sector because Canadian oil is sold at a discount and for the Canadian sector to outperform requires a very bullish outlook on the sector, or a spike in natural gas prices. The safer play is the U.S. sector, although natural gas may provide support in April as it often does.
After a run of outperformance in January the energy sector has been underperforming. In my video that was released at the beginning of April, I discussed the energy sector, highlighting its typically strong seasonal performance for April. Since 1990, on average, the energy sector has been the top performing sector when compared to the other major S&P GICs. From 1990 to 2011, the energy sector outperformed the S&P 500, 68% of the time and produced an average gain of 3.2%. Given the seasonal sector strength of the sector and the fact that it had not broken down below a major support level, it made sense to have an investment in the sector.
So far the results for the energy sector in April have been a slight underperformance compared to the market. The technical breakdown point for Energy Select Sector SPDR (XLE) is $75, at which point investors should be looking to exit the sector. The seasonally strong period for the sector ends on May 9th. The energy sector has performed at market over the last year, including its outperformance during the seasonally strong summer period. Currently, the sector’s relative performance is not very impressive and if the sector were to show strong underperformance in April relative to the S&P 500, then exiting this position early is justified.
As I discussed last month, both the Canadian and U.S. energy sectors can perform well, but investing in the Canadian energy sector is making a bet on one of two scenarios: a strongly bullish outlook for the energy sector, or a rapid rise in natural gas prices.
During the summer seasonal period for energy, both the U.S. and Canadian sectors increased in value. Despite the increase, the Canadian sector was only able to perform at market. Over the last few months, it has been underperforming both the market and the U.S. energy sector.
The discounted western Canadian oil, along with its higher production costs is in effect leveraged to higher oil prices. Higher oil prices provide a greater margin expansion for Canadian operations, compared with other nations that have lower production costs. As a result, if the Canadian energy sector does start to outperform the market and the U.S. energy sector, this will be bullish for the overall energy sector. This would be good news.
The energy sector started its seasonal outperformance early this year, in January. Recently, it has pulled back as the “official” season started. Last year the energy sector did not perform well in its seasonal period as the deep cyclicals were performing poorly and the overall market index was rising. It is totally possible that we see the same action this year, especially given that the metals and mining sector performed so poorly in February. So far a positive sign is that the oil stocks have been holding up well relative to the declining price of a barrel of oil.
HAC, in January, started to accumulate positions in the oil services sector, oil exploration and production and the overall sector in Canada and the U.S.
I developed a seasonal strategy for the exploration and production energy sub-sector. On average this sector performs well from January 30th to April 13th. It is a positive sign if this sector starts its seasonal outperformance early, which has happened this year. HAC has benefi ted from taking a position in this sector in January with SPDR® S&P® Oil & Gas Exploration & Production ETF (XOP). At this point it is still expected to outperform.
Oil Services- Performing well
The oil services sector has also started its seasonal run early. Its seasonal period typically ends on May 17th. Given its early start it is possible that the sector finishes its seasonal run early, but we are still some time away from making that call. HAC took a position in this sector in January with Market Vectors Oil Services ETF (OIH).
Energy-Started early, could take a pause, but still bullish
This year, the energy sector has started its outperformance early. Last year the energy sector followed the same pattern of an early start and then faltered as it entered its typically strong period from February 25th to May 9th. The overall run-up this year prior to the beginning of the seasonal period is much less than last year, making the sector much less susceptible to a sharp correction. Currently, XLE is pushing up against the resistance level set back in 2011, but the overall pattern is bullish as the sector has been making higher lows. It is possible that the sector takes a pause before its starts its outperformance once again in a few weeks. Nevertheless, at this time the signs are still bullish.
Why has Canadian energy been underperforming?
Canadian energy has been underperforming U.S. energy because of the future expectations of the natural gas and oil prices. First, the Canadian energy sector has a higher percentage of natural gas and if natural gas prices are expected to be lower in the future, this shows up as a weaker performance for the overall Canadian energy sector. Second, Canadian oil is expensive to produce and sells at a discount to West Texas Intermediate Crude. In other words, the margins are lower. Although this should mean that a price expansion should generate a greater percentage profi t, compared to American companies, it also means that Canadian companies have a greater exposure to production cost risks. The thinner margins translate into a substantial decrease in profi ts if production costs increase. This has been clearly demonstrated by Suncor reporting a loss, as it took at $1.5 billion write-down on its Voyaguer Upgrader.
In the current market environment investors perceive the risk of production cost increases as having a greater impact than the possibility of a longer-term increase in the price of oil. If the Canadian energy sector does start to outperform the U.S. energy sector, this will be a bullish condition for the overall sector.
The energy sector has its strongest seasonal period from February 25th to May 9th. During this time period, from 1984 to 2012 the sector has produced an average return of 7.4% and has been positive 83% of the time. Although this trade has been successful over the long-term, in the last three years the trade has been unsuccessful. Over the last two years the energy sector started to outperform in September and October, well ahead of its typical seasonal period. By the time the seasonal period arrived, the sector had exhausted itself and started to correct. This year, in the last few months the energy sector has not outpaced itself, setting up for a good seasonal run.
Oil & Gas Exploration and Production
In the past, I provided a strategy that included a seasonal trade in the oil and gas exploration sector that started at the end of January. So far, the sector has been consolidating and is poised to perform well. Investors should be looking to enter this trade shortly.
iShares Cdn Capped S&P/TSX Energy (XEG)
On the proceeds of its sells in the month of March, HAC has been favouring the Canadian market, including the energy sector. Earlier in March an additional allocation to XEG was made. Although the XEG has produced positive results, overall it has been lagging the market.
Recently, the energy sector has been showing more strength. In 2008 the energy sector bottomed in the beginning of March, as did it in 2009. It is possible that this year the sector’s strong performance might be a bit delayed. There is overhead resistance at $19.50 for XEG.
We are still in the strong seasonal period for the energy sector, and as such, the sector is expected to reach the resistance level. Caution must be used if XEG breaks through resistance and then falls back below at the time when seasonal strength ends for the energy sector.
Investors also have the option of extending the seasonal trade for the energy sector if XEG rises above resistance with strong momentum. The resistance line can be used as a support line and the position sold if the sector comes back down to the resistance or loses its momentum.
Keep in mind that the average date for the energy sector’s seasonal strength to end is May 9th. Over the long-term this has proven to be a very successful date.