The Futures Report

Trading the World’s Markets;

May 4,2007

                                                            
Matthew Caruso, CMT                                 
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Crude Oil & the XLE (Energy Sector SPDR)

    With gas hitting record levels at the pumps and drivers following gas prices closers than the NHL playoffs, most people logically come to the conclusion that the price of Crude Oil must be climbing. However, as is often is the case, the markets are not completely logical and Crude prices have actually been falling as drivers pay record prices to fill up heir cars. In fact, markets tend to hit their speculative peaks at times when ordinary commodities become a topic of discussion for the general public. Therefore, it is important to analyze the price of Crude and the impact that a fall in the commodity will have. One of the best ways to gauge what prices of a commodity will do in the future is to see what the smart money is doing, let’s study the commercial traders.


Figure 1 Crude Oil

Figure 1 is a chart of Crude Oil prices with the index of commercial traders in the bottom panel. As can be seen, the smart money is bearish on crude. Commercial traders have been at the same bearishness as current levels 3 other times in the recent past as highlighted in figure 1 with blue vertical lines, and each time has coincided with a fall in prices for the commodity. As well, the uptrend that started in the Crude Oil in early 2007 has now likely ended due to the fact the uptrendline has been broken, as can be seen in the upper panel of figure 2. This potential continuation of falling Crude prices may have a bearish effect on energy stocks. With most market averages at 52 week highs, it is easy to become overly enthusiastic and buy any stock in any sector. However, Crude Oil prices have been a leading indicator for energy stocks at tops. Figure 2 outlines 2 other situations similar to the current situation where Crude Oil prices break an uptrend line and form a negative divergence with the Energy Sector. The bearish divergences are highlighted with red lines. In September 05’and July 06’ Crude prices went sideways or fell as energy stocks continued to rise, setting up bearish divergences and an eventual fall. Therefore energy stocks must be monitored closely and any fragmentation of the uptrend  in energy stocks must be closely watched because they may begin a strong fall.


Figure 2 Crude Oil & XLE

Gold, Gold Stocks & the U.S. Dollar

    Anyone following Gold stocks and the price of Gold during the past year would easily recognize the underperformance of Gold stocks in comparison to the yellow metal. Figure 3 shows the steady climb in Gold prices from the 2006 low has been matched by a sideways triangle formation by Gold and Silver stocks which are represented by the $XAU (Gold & Silver Index).


Figure 3 Gold & $XAU

What does this mean and more importantly what should we expect for the future of Gold and Gold stocks? The answer to these questions may lie with what happens to the U.S. Dollar. Figure 4 shows the U.S. Dollar Index in the upper panel and Gold prices in the lower panel. These two commodities typically move in opposite directions for a number of reasons, one being that Gold is quoted in Dollars. When the U.S. Dollar’s major uptrend was broken in 2002, Gold similarly broke its major downtrend. Although the U.S. Dollar is currently in a downtrend, it’s coming up against a major support level which is highlighted by a horizontal red line in figure 4. The important point to watch would be to see if that support level holds or breaks. If the Dollar fails to make a new low and turns up, Gold will likely fail to make a new high above 732, which will then be followed by Gold stocks breaking down from its triangle pattern. However, if the U.S. Dollar makes new lows, Gold will likely climb higher and indecisive Gold stock investors will likely push Gold stocks out of their consolidation triangle pattern. Either way, Gold & Gold stock investors should keep their eye on the U.S. Dollar.



 Figure 4 Gold and the U.S. Dollar