The United States Oil Fund (NYSE: USO) appeared on my bearish scan on Tuesday evening, but it wasn’t the stock or ETF that stood out the most that evening, so I opted to write about Potash (POT) instead. However, I kept USO’s appearance on the bearish list in the back of my mind and I also took note that ConocoPhillips (NYSE: COP) and ExxonMobil (NYSE: XOM) were on the bearish list Tuesday evening. When I ran the scans last night, Chevron (NYSE: CVX) and Marathon Oil (NYSE: MRO) both made the bearish list.
This led me to go back and look at the daily and weekly charts of the United States Oil Fund. Two things stood out on the daily chart: the fact that the fund is hovering right at its 50-day moving average and that the fund just moved out of overbought territory.
Looking at the weekly chart, I was able to create a trendline by connecting the highs from the past three years and that trendline is just overhead at the $38 level. However, there is also a trendline down at the $33 level that connects the lows from the past 20 months. These two trendlines are compressing the price of the fund and when a stock is being compressed, it tends to explode in one direction or the other.
Normally I would recommend playing a straddle with 35 strike options, but there is something beyond the charts that makes me think USO will fall before it rises and that is the sentiment toward the fund and toward oil in general.
There are a number of sentiment indicators you can look at for individual stocks. My favorites happen to be the short interest ratio, analyst ratings and the put/call ratio. When you have a fund like USO, you only have two of these three indicators at your disposal. The short interest ratio for USO is 4.4, which is not too high and not too low. The put/call ratio is at 1.14 and that is lower than 74% of the readings for the past year. Between these two indicators the sentiment has a slight bullish skew (meaning a contrarian views this as bearish.
The biggest bullish sentiment comes from the oil futures. Each week the Commodity Futures Trading Commission publishes the Commitment of Traders report for each commodity and futures product on the market. The reports are broken down into three categories: large speculators, small speculators and commercial hedgers. For each category, the report shows a net position for the group. For instance, if the large speculator group has 100,000 contracts held long and 50,000 held short, the net long position is 50,000 contracts.
This past week’s COT report showed that large speculators are net long 391,174 contracts. To put this into perspective, the group had NEVER been long more than 400,000 contracts until February of this year. Even with oil prices falling for the better part of the last five weeks, large speculators are still holding a huge long position. With such a large position long, it could take a while to unload these positions and it will create significant selling pressure on oil. Because the United States Oil Fund is a direct reflection of oil prices, the selling pressure will extend to the fund as well.
I look for the USO to fall to the $33 level at the very least and if that trendline gives way the next support level is $31 and then down to $29. Shorting the fund is the easiest way to play it and you can stagger your exit with each of these support levels. If you are an options trader and want to play a straddle, I would recommend options that are a few months out as it could take time to play out.
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