Another Oil vs Oil-Stock Divergence

By Dr. Duru written for One-Twenty

July 6, 2006

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What gives? Oil prices hit new 52-week highs on Thursday (and a new all-time nominal record) at $75 for August delivery, the oil inventory report showed a surprisingly large drawdown for the week, hurricane season is upon us, and demand for gas (car fuel) is as robust as ever. Yet, oil-related stocks continue to lag. When I wrote about a similar divergence two weeks ago, the general picture in the oil patch was full of broken down and oversold stocks. Now, after two weeks of recovery, many of these same stocks are starting to hit into thick levels of resistance like price ceilings, 50 and 200 DMAs. I was surprised to see how many of these stocks had down days of 1% and more. Just as I did two weeks ago, I decided to do some quick statistics. The field of stocks I periodically review (up to 128 now), includes 34 stocks whose prices are 90% of their 52-week highs. That means that only 26% of these stocks are anywhere close to their 52-week highs while oil is hitting its 52-week high! For confirmation, I looked at the stocks in the iShares ETFs for oil and gas exploration and production (IEO) and the oil equipment and services index (IEZ). I got the same story. Only 27% and 25%, respectively, of the stocks in these indices are at least 90% of their 52-week highs.

Given that these stocks are starting to look extended, I am less inclined to be bullish like I was two weeks ago. But, I imagine this divergence will be resolved soon...and perhaps in swift and abrupt motion. While I remain long-term bullish on the oil patch, I have begun wondering aloud whether a big correction is coming for oil. Certainly, the continued pressure on oil prices is going to keep the Fed awake at night with nightmares of endless rate hikes. If the Fed is as serious as they seem about cooling off the U.S. (and global?) economy, then I have to expect that at some point they will finally crush us...along with this robust demand for oil. (Note that this fall will be cushioned somewhat by continuing supply issues around the globe). Until then, I suppose oil-related stocks will continue to struggle to catch up....or is this divergence telling us that a big correction is right around the corner? Hmmmm.......

In a final side note, my report on the June trading pattern in Omni Energy Services (OMNI) came just in time for the pattern to change. I suspected as much at the time. Instead of correcting in the first 3 days of the week, OMNI enjoyed an entire week of daily gains. All told, the stock moved up a heady 23% that week! An upside surprise to earnings guidance helped lift the stock big on that Wednesday. (See my disclaimer here)

Be careful out there!

DrDuru, 2006