By: Ogo Nwanyanwu
The spread of civil unrest across countries ranging from North Africa to the Middle East has given crude the catalyst it needs to awake from its Winter slumber in 2011. Brent Crude has more than answered the call, spiking to over $104 a barrel Wednesday, on news that Iran sent warships to the Suez Canal and Israel voicing its displeasure, calling Iran’s actions, “provocation.”
Yet, with the increase in geopolitical tensions across the globe, West Texas Intermediate crude repeatedly hits the snooze button as the spread between Brent crude and WTI crude (normally $1 or $2 in WTI’s favor) has reached over $18 in Brent’s favor. Weather in U.S. has been a major factor, with American drivers constantly waking up to subfreezing temperatures, howling winds and their cars covered in snow by the latest storm of the week. Even as WTI crude lags most other commodities and the major US Indexes, oil stocks continue to lead the market higher.
At these levels in the stock market, active investors may begin to question the intelligence of staying with oil stocks. But with WTI crude yet to join party, there is still more upside potential in oil stocks. A quick look at historical price data over the last decade will show that WTI crude, when purchased in mid February and sold in early June, has traded higher in every year of the last 10, except for 2001 and 2003.
Fundamentally, the US economy continues to improve and temperatures inch up across the country; gas prices still remain below levels that would affect demand. Technically, the bullish argument would seem suspect, WTI crude has been relatively weak across multiple markets, sectors and commodities. Early this week, WTI crude traded below January pivot lows while Brent crude and oil stocks made new highs. With all that said, technically this action is really the same old two-step for WTI crude.
Earlier it was mentioned that WTI crude traded higher between mid February and early June in eight of the last 10 years. In six of those eight occurrences, during the month of February, WTI crude either retested or traded below January’s pivot low, before finally making it’s move higher, never looking back. Marc Sperling calls this type of price action ‘shaking the tree’ to get the weak longs out… when referring to WTI crude, I call it the West Texas Two-Step.
First step of the pattern, establish a pivot low in January, with the second step being a February retest or breakdown failure. Crude put in a pivot low of $85.11 on January 31st, then this week pushed thru that Jan. pivot to 83.85 only to trade back above it on Wednesday, closing at $85.20. Active traders with access to futures, can get long and give themselves to the Feb. pivot low. Active investors should stay with their preferred oil stocks or the Oil Service HOLDRs ETF (OIH).
Avoid buying at new highs, but look to buy stocks as they retest their 20-day moving averages or on gap ups after multi-day retracements. The 2011 high in WTI crude of 93.02 is my initial target, with the downside risk around $1.50 based on an entry below $85.50, using the $83.85 area as the stop. The trade set-up presents a reward to risk ratio of 5 to 1… double that to 10 to 1 if WTI crude hits $100. This two-step becomes all the more inviting with Iran as a dance partner.
*DISCLOSURE: No position mentioned (subject to change)
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