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A Word in the Ear of Oil Share Investors

Clive Maund
4 August, 2004

Many precious metal share investors also invest in oil shares, as they are investors in resource stocks generally, and can be expected to gravitate towards any sector that is hot, which the oil sector undeniably is at present. I therefore consider it appropriate, and timely, to write about oil stocks at this time.

This article is directed at those who are already invested in oil stocks, and also at those who are considering "having a go."

Clearly the sector is red-hot at the moment, and normally, when you hear financial commentators on CNBC and CNN talking at length about the prospects for a sector, as they are now with oil, it's time to start thinking about abandoning ship. However, this time it's not that simple, and if you jump ship too early, you may miss out on some spectacular gains. Equally, you don't want to get left holding the bag when the thing burns itself out. The purpose of this article is to assist in delineating parameters, the use of which will enable investors to be around for any big gains, and to be out at or soon after a top, thus maximising gains.

As we shall see, the charts allow for a wide range of possible price objectives. This reflects the fact that one of the primary drivers for this market, in which the supply and demand equation is now very finely balanced, is the intrinsic instability of Saudi Arabia, a country that is threatened by insurrection and possible anarchy, and that may ultimately require intervention by the Axis powers (USA, UK and Israel). There is also the potential for supply disruption in Venezuela.

We'll start by looking at a long-term chart for oil itself, using the chart for West Texas Light Crude going back to 1990. On this long-term chart we can see that the price had a preliminary breakout some weeks ago, breaking above the highs of 1990, 2000 and early 2003, before dipping back to fund support in the area of its 200-day moving average. Just over the past couple of weeks, however, it has broken out decisively above the major resistance of the earlier highs, and, although it could peak about now, the odds favour a sharp advance over the short to medium-term. In fact, this is a chart in position to make a parabolic spike whose extent will depend on the degree to which a supply crisis manifests.

Our next chart shows the action over the past 2 years in more detail. On this chart we see that the price is once again approaching the top line of its intermediate uptrend channel.

Now to consider the charts for the oil stock indices, which at first sight appear to be very bullish, and to corroborate the bullish look of the oil charts. Two charts are presented below, one for the AMEX oil index and the other for the CBOE oil index. They are very similar in appearance and in the interest of brevity will be discussed as one. On these charts we can observe the intermediate uptrend that began early in 2003 and remains in force. Most investors looking at these charts would consider them to be very bullish, after all, a strong uptrend remains in force and we have recently broken out to new highs. They would not see the BEARISH FLAT-BOTTOMED BROADENING FORMATIONS on these charts. These formations are not very common and are indicative of a wild, out-of-control market that is approaching a terminal juncture.

Statistically, 90% of these formations end in a bear market breakdown. This is not to say, however, that we can't have a final spectacular blowoff run towards, or even beyond the top lines of these formations. After all, these patterns started to develop way back in 1997, so a breakdown is not necessarily imminent.


How then do we reconcile this apparent contradiction between the bullish charts for oil itself, and the longer-term bearish implications of the oil index charts? The only fundamental explanation that I can think of that is congruent with the message being given by these charts is that the high oil prices will be yet another factor helping to crucify the economy, which is already in a parlous state beneath the veneer of manipulated statistics, and that the general stockmarket will in due course plunge, taking oil shares with it, as economic recessions/depressions are not noted for being good for corporate profits, even for oil companies. This will be the time when the precious metals really shine -- when the fiat money system is in a state of acute crisis.

Alright, so what are the most effective strategies or tactics for oil share investors, or would-be oil share investors? There are potentially big gains to be made over the short-medium term in this sector, but as we have seen, the oil index charts are already flashing warning signals, and that means it's prudent to have an exit strategy in place for when things turn sour, which, if you are unlucky, can happen very soon after you buy, in which case it's important to 'take your lumps' and exit with a minor loss rather than holding on and hoping.

Fortunately, there are clear uptrend channels in existence in the oil indices, and in many oil stocks. The right tactic, therefore, whether you are an existing holder of oil stocks or a new buyer is to remain long while these uptrends remain intact, but to exit immediately on a clear break of the uptrend. The uptrend channels on the 2-year charts for both the AMEX and CBOE oil indices are shown below.

An example chart for one of the oil majors is shown below, Chevron Texaco. Here we see the continuing strong uptrend -- only yesterday the price staged a powerful high volume breakout above the 1999 highs, although the long-term chart shows a dangerous broadening formation. The message is clear, it's fine to stay long and ride it, but hit the exits on a clear break below the intermediate uptrend line that started in 2003.

Chart analysis of the other oil majors has been undertaken on my website, for the benefit of subscribers. [You can subscribe here].

4 August, 2004
Clive Maund

Clive Maund is an English technical analyst, holding a diploma from the Society of Technical Analysts, Cambridge and living in southern Bavaria, Germany where he trades US markets.

Visit his website at clivemaund.com

No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.

Copyright ©2004 CliveMaund. All Rights Reserved.

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