It’s not too late to buy oil stocks, just follow this strategy
There seem to be some
murmurings that due to the influx of new assets into natural resource and
commodity driven funds that the bull market in commodities will be very similar
to the boom/bust in technology. That is probable. The economy is cyclical and
our current economy happens to be in the phase of the cycle where commodities
rise in price (late expansion). No sector or asset class remains strong
forever. Skittish investors need to remember that investing primarily in one
sector is not for the buy and hold type. Sector investing can be risky if not
managed correctly.
The question that is most
important at this juncture is, “I haven’t been involved in the oil and commodity
driven sectors. Is it OK to make a purchase of a natural resource/commodity
driven fund, or are we topping?†Whenever you buy anything you’re taking a risk
that you are paying too much. How many of you have ever bought a house? Did
you think that maybe you were paying too much and that you would never be able
to get out of it with a profit? Those questions may be especially relevant for
recent home buyers. By the way, is real estate a commodity? That is a
topic for another discussion. Let’s examine some charts to see what we can find
out about traditional commodities.
The Reuters/Jeffries CRB Index
has been in a bull market since June of 2002. As you can see, the chart (below) was
able to give a double top buy signal and break above its bearish resistance line
that had been in place since March of 2001. Previously there had been a brief
period of bullishness that began in January of 2000. For those unfamiliar with
the point and figure method, the numbers in the charts represent the months of
the year. The letters A, B, and C stand for October, November, and December.
The first mark on the chart in the month is made with a letter or number,
whichever applies. The Index has pulled back to support a couple of times since
its bullish breakout but has never broken through. The return (in percentage
terms) has been approximately 61.16% since the rally began. For some
perspective, let’s look back at the last time the CRB Index rose dramatically.
At the end of November 1980 the
Index, on a monthly close, topped out at approximately 334.80 (www.crbtrader.com).
We are currently trading right around that level and have gone as high as 337.18
on the daily close. The yield on the 30-year Treasury bond during that same
time period was 12.37%. It is also interesting to note that before the top in
the CRB in 1980, the 30 year had been consistently rising and actually did not
top out until AFTER the run in commodities was over (typical). At the end of
October of 1981, the 30-year was yielding 14.681%, while the CRB Index was at
268.30, almost 20% off its’ highs. In case you’ve been living under a rock, you
will know the
current 30-year is nowhere near those levels. We are now (9/30/05) yielding
4.57%, compared to a yield of 4.88% at the end of the year. Despite the Federal
Open Market Committee’s best efforts, the long term yield has not consistently
risen this year. These are all things to keep in mind as we look at the current
picture of the CRB Index.
Recently, the chart has formed
a symmetrical triangle with a bullish completion. The chart formed 5
increasingly narrow rows of alternating Xs and Os and then gave a new buy signal
(on the 5th row) at 332. The CRB Index remains positive and will continue to
remain positive until it breaks through its support (and a double bottom) at
310. In other words, the long term picture of bullishness will remain intact
until the support line is broken.
Another question that needs to
be answered is- where do we think this index can go from here? In order to get
a meaningful price objective, let’s look for the most recent spike in demand
(rise in price=long stream of Xs) in order to do our “vertical countâ€.
Normally, a vertical price objective is gained by finding the first buy signal
off the bottom of the chart and starting the count there. Because the
bullishness has been long running and the chart has met and exceeded many price
objectives (typical of strong stocks/indexes), then we must look a little harder
to find a price objective. If we work backward, the most recent sell signal in
the index was at 296 in May of this year. The next buy signal after that was at
312 in June. In order to get the price objective, count the number of Xs in
that stream (9), multiply by 3, and then multiply by 2. Multiply by three
because it is the three-box reversal method and then multiply by 2 because each
box is worth 2 points. And, yes, you can just multiply by 6. The answer is
54. Now what? Add that answer to where the chart made its’ most recent bottom
at 294 (May). Three forty-eight. We are at 334 now and we can possibly go to
348-350. There seems to be some room left to the upside; however, not much-only
about 4%. Something that I just can’t ignore about this chart is the spike in
demand that occurred in March. If we do a vertical count from that area (the
first buy signal after the sell signal that occurred in November of 2004), we
get a price objective of 398 (20*6+278). A move from 333 to 400 seems a little
more significant-20%. A twenty percent move is worth a trade.
The first price objective that
was calculated above does not warrant a trade. Since we have two (at least)
conflicting views, let’s look at one more indicator in order to determine
whether or not we should buy now or wait. I would look at more than just one
additional indicator, but, in order to avoid information overload, I will just
go through one of the ones’ that I would examine.
To be simple, the Relative
Strength Index compares a stock’s (index’s) gains versus its losses for the past
14 days. A daily tally is kept. The index is an oscillator, which just means
that it travels between two extremes. The generally considered overbought point
is at 70 and the oversold point is at 30. For the CRB Index, the RSI is
currently at 59.6. That would make it not overbought. To remain firmly
bullish, the RSI shouldn’t go below 50.
If you are not already involved
in the commodity side of equities, I think it is fine to buy either an oil or
steel or other metal type stock (natural resource mutual fund or commodity
driven one). Just don’t overload it. Wait for a pullback to between (328-324)
before you bet the bank. As for making a bullish trade on the futures for the
index, I would be quite cautious here as that type of investing requires more
precise timing and, for the short term, the index does seem a bit overbought
based on the meshing of the various factors discussed above.
Sara Conway
Sara Conway is a
registered representative at a well-known national firm. Her duties
involve managing money for affluent individuals on a discretionary basis.
Currently, she manages about $150 million using various tools of technical
analysis. Mrs. Conway is pursuing her Chartered Market Technician (CMT)
designation and is in the final leg of that pursuit. She uses the Point and
Figure Method as the basis for most of her investment and trading decisions, and
invests based on mostly intermediate and long-term trends. Mrs. Conway
graduated magna cum laude from East Carolina University with a BSBA in finance.