Oil and Gas Trends for 2016

And we're back! The Thanksgiving holiday winds down into the last month of the year with highlights of the Christmas season. The Federal Reserve also moves into territory for their next decision concerning interest rates in mid-December. Trading on Monday and Tuesday were both mostly flat with small losses at the beginning of the week bouncing to parsed gains on the second day of the week. Today, the S&P 500 trades up 15 points or 0.72%, the Dow Jones Industrial gains 132 points or 0.72%, and the NASDAQ up 33 points or 0.64% at about midday. The bounces seem a bit premature, though, as the ISM manufacturing index reveals a contraction (first in 36 months) in November. From October, the index fell 1.5 points to 48.6 points, new orders fell 4 points to 48.9 points, and production dropped 3.7 points to 49.2 points. The numbers look disparaging at first as one of the largest declines in the year, but looking at October's uncanny rally, November's numbers may be normalized with this in consideration. Perhaps investors are recognizing this disparity and continue to support the positive movement on the day. Around 10:00 a.m. an initial trough occurred with the introduction of the news, but upside hopes continue to define how traders act through the end of the year. Also moving downward were retail sales for Black Friday weekend and store traffic during that time. Although not an important observation, it may lend itself to an argument for diminishing consumer spending and could foreshadow something smaller over December. A WSJ report discussed both a drop in capital expenditures on the corporate side accompanied by stagnating consumer spending numbers. These kinds of reports have populated the equity and economic discussions in the latter half of the year with the August correction scaring a lot of money away from upside trend hopes. Even then, equity prices continue to be held up despite the cost of money rising, and for some, that may signal a bubble-like pattern. There will definitely be a small deviation from stocks as their return in the future is pared and bond yields begin to increase. The real question will be, from where will the capital exit and if there will be enough remaining to support the bullish market of about 7 years. On top of the worsening of the manufacturing index and an apparent outflow of capital in the markets, central bankers are coming to terms with the potential of "policy divergence" between the European Central Bank and the Federal Reserve. The two most powerful monetary institutions in the world might see opposite policy decisions as the Fed makes rate hikes a clear goal in mid-December and the ECB considers more easing this week. Investors will be looking at reactions from the dollar and euro relationship as well as export and import relationships between the two areas. Predictions are muddled by a historical eye casting a negative outlook on the prospects for divergence. In a time of global weakness, where all countries are feeling squeezed, harmony in policymaking could make the difference for confidence. But the eurozone continues to lag behind in equities markets with losses of -0.76% this Tuesday despite the possibility of more stimulus. Perhaps this is an investor response to the exhaustion of easy money policy and the irreversible fluctuations of the business cycle. In Europe where easing has been going on since the financial crisis in 2008, I refer back to my article on the complex relationship between employment and inflation. Particularly, the emphasis on the shifts of the Phillips curve due to changes in expectations should be considered as the culprit of limp monetary easing in the eurozone.

Bouncing from support to 50-day moving average

Where do oil and gas come into the big picture? Besides low oil prices being the main factor instigating the problem of lower inflation, energy firms have led the decreases in capital expenditures and overall business investments that typically lead to more growth. But, they've done this out of necessity, for the sake of their dividends and their share prices (well, what's left of them). Just last week, commodity traders traded WTI crude oil below the $40 level which had been a support over the past month or two. Near the end of last week and the beginning of this week, trading has bounced out of the brief foray into the $30's normalizing to the lower bound that had been established for a while. In today's trading session, WTI price settled -0.13% lower, but continues to maintain gains of about 6% for the week. Everytime spot prices for crude oil reach to the high $30's, a bullish recovery sends prices a dollar or two above $40. In the chart above, recoveries appear to be reaching for 50-day moving average levels as a provisional resistance point (shown by the blue circles). In my opinion, traders have anchored in their minds that $40 is the absolute support level for the price of WTI which is why the rebounds can be observed. Estimations and projections below this "implicit" support seem invalid to me for this reason. This could be attributed to the establishment of limit trades at $40 which would trigger buying and cashing of shorts in large groups. It may also be the mentality of the market, which has been formed under the iron grip of OPEC, that prices are not decided in a free market but instead are dictated by a cartel-like force. OPEC meetings and announcements still affect trading on and around the day of the event even though the member countries have lost a significant amount of market share. Countries who have been most hurt by low oil prices continue to believe in the price fixing system and continue to claim OPEC action against prices. It appears that the only country that has conceded the fact that oil markets are finally free is the largest petroleum producer in the world, Saudi-Arabia. Throughout the year, their petroleum experts have projected oil prices in the $30's, and the government officials refuse the calls for a quota on production. This puts U.S. oil and gas companies in the best position to flourish in the coming year. The same firms that have captured market share with the development of fracking are now cutting capital expenditures by millions in order to survive the glut. Something tells me their share prices are not determined by the prices of the commodities anymore.

WTI and equity deviations

It may have something to do with charts like these. The graphs above trace return from investments in WTI and S&P oil and gas ETFs over the past 60 trading days. From the beginning of the year and even before that, oil and gas companies were assumed to follow the prices of their respective commodities for appropriate valuation. This fact became well-accepted under market conditions determined by OPEC's massive market share and dictated a lot of price movement through 2014 and 2015. I think that is going to change in the end of 2015 and going into the new year. As quarter four begins to close in December, analysts and economists begin to muse about what 2016 will bring for the markets with interest rates beginning the gradual hike upward and a stronger dollar in the very near future. My prognosis for energy shares is that a deviation from their dependence on commodity prices will become evident as free market forces are realized in the sector. Firms have already seen the necessity of cutting costs in order to stay competitive, and investors are finally trading upon that fact as well. First evident at the end of October and the beginning of November, oil and gas equities have begun a deviation from WTI benchmark performance. While prices for crude oil have lost -9% in the past 60 trading sessions, S&P Oil and Gas Exploration (XOP) and S&P Oil and Gas Equipment (XES) have maintained gains of about 1% and 2%. This differs from movement in October which saw all three securities following each other. This pattern stands a good chance of continuing as oil and gas firms retain their objective of increasing competitive advantages in the industry while other sectors might not have the same incentives to do so. While employment in the sector has been hurt, necessary investment spending cuts have been paired with aggressive marketing and negotiating in order to preserve decent revenue levels. With futures contracts showing projections of higher prices in 2016, the sector could become a winner even as overall market predictions have been lukewarm. Long-term positions in solid mid- and large-cap stocks are the best ways to capitalize on this trend, but investors should buy now and buy low to establish the most price security in their equity choice.