It's one of the biggest questions in the market right now... And we're worried lots of people are getting the answer wrong.
The question: Is it time to buy oil stocks yet?
In late July, we warned DailyWealth Traders that crude oil was due for a decline. We pointed out that sentiment (as measured by fund-manager positions) was extremely bullish toward oil, which is a bearish signal.
Since our warning, oil has crashed. It's fallen from $102 per barrel to $45 per barrel. As contrarian traders who hunt for crisis situations, oil has been on our radar...
Some folks are already buying oil stocks. They believe they've hit bottom. For example, top financial weekly Barron's recently ran a cover story that encouraged readers to buy a handful of oil stocks. Many of the talking heads on financial television say they're buying oil stocks.
Other than buying them for a very short-term bounce (like 1-2 weeks), we recommend NOT buying oil stocks right now. There's a great chance some "sandpapering" is on the way.
And it's important that you know what sandpapering is...
In June 2013, we published an essay in DailyWealth Trader on "The Guillotine and the Sandpaper." In the essay, we explained the idea...
It was first described by legendary market analyst Bob Farrell...
You start with a dramatic drop [in asset prices]. Prices fall 20%, 40%, even 70%. That's the "guillotine." Then comes the "sandpaper": a period where prices move up and down without going much of anywhere. This go-nowhere action exhausts anyone who is still left holding. Eventually, everyone gives up. When there are no sellers left, prices can start to rise.
In other words, the guillotine is what happens when a market suffers a sharp selloff in a short time... and sets up an opportunity to trade a recovery. But before the recovery takes place, the asset often spends months or years moving sideways. That's the frustrating sandpaper phase. It's just how the market works.
Consider our huge winning trade on aluminum giant Alcoa. In 2011, Alcoa suffered a near-50% drop. Instead of rebounding quickly, it "sandpapered" shareholders for two years. We waited... and jumped in right as the sandpapering ended. We made 80% in less than a year. You can see sandpaper phase in the chart of Alcoa below:
Or... consider airline stocks over the past four years.
In 2011, airline stocks suffered a huge 45% drop. And while they ended up recovering and running higher, they spent more than 15 months trading sideways. They spent more than 15 months "sandpapering" traders who bought right after the drop. Then in late 2012, airline stocks started moving higher. You can see that sandpaper phase in the chart of leading airline Southwest Airlines.
Again, sandpapering after the guillotine strike is usually how the market works. It takes time to absorb the shock of lower prices and form a bottom.
And since many folks are still bullish on oil stocks today, we believe they'll trade sideways (or even lower) for at least several months. It could take more than a year for the sector to digest its huge recent loss... and frustrate the people who just bought shares.
You can see the guillotine in this two-year chart of the Dow Jones U.S. Oil & Gas stock index...
Now that oil stocks have suffered the guillotine strike, expect a sandpaper phase. The vast new supply of oil from North American fracking should keep prices below $60 for years.
These lower prices will start filtering through oil-company income statements and balance sheets. Companies will report much lower asset values. They'll start reporting shockingly low earnings. Some of the companies that have taken on lots of debt will go bankrupt. We're sure a few companies will be busted for questionable accounting and overstating reserves (it always happens after major tops).
There will be a relentless supply of bad news from this sector... which will keep the investment public away.
Of course, we can't know how long the oil sector will take to frustrate the people who just bought in. But it's likely to be at least six months. We're sure experienced short-term traders (like our friend and colleague Jeff Clark) will be able to trade short-term rallies. But for traders and investors with longer time horizons, it's best to avoid oil stocks right now. They're due for a sandpaper phase.
When oil stocks finally rally, the gains could be enormous. But it's best to stand aside right now. We're monitoring the sector closely... And we'll update you as it plays out.
But for now, we'd much rather focus on sectors that will benefit from consumers paying less for gasoline... Stay tuned for more on this idea.
Regards,
Brian Hunt and Ben Morris
The question: Is it time to buy oil stocks yet?
In late July, we warned DailyWealth Traders that crude oil was due for a decline. We pointed out that sentiment (as measured by fund-manager positions) was extremely bullish toward oil, which is a bearish signal.
Since our warning, oil has crashed. It's fallen from $102 per barrel to $45 per barrel. As contrarian traders who hunt for crisis situations, oil has been on our radar...
Some folks are already buying oil stocks. They believe they've hit bottom. For example, top financial weekly Barron's recently ran a cover story that encouraged readers to buy a handful of oil stocks. Many of the talking heads on financial television say they're buying oil stocks.
Other than buying them for a very short-term bounce (like 1-2 weeks), we recommend NOT buying oil stocks right now. There's a great chance some "sandpapering" is on the way.
And it's important that you know what sandpapering is...
In June 2013, we published an essay in DailyWealth Trader on "The Guillotine and the Sandpaper." In the essay, we explained the idea...
It was first described by legendary market analyst Bob Farrell...
You start with a dramatic drop [in asset prices]. Prices fall 20%, 40%, even 70%. That's the "guillotine." Then comes the "sandpaper": a period where prices move up and down without going much of anywhere. This go-nowhere action exhausts anyone who is still left holding. Eventually, everyone gives up. When there are no sellers left, prices can start to rise.
In other words, the guillotine is what happens when a market suffers a sharp selloff in a short time... and sets up an opportunity to trade a recovery. But before the recovery takes place, the asset often spends months or years moving sideways. That's the frustrating sandpaper phase. It's just how the market works.
Consider our huge winning trade on aluminum giant Alcoa. In 2011, Alcoa suffered a near-50% drop. Instead of rebounding quickly, it "sandpapered" shareholders for two years. We waited... and jumped in right as the sandpapering ended. We made 80% in less than a year. You can see sandpaper phase in the chart of Alcoa below:
Or... consider airline stocks over the past four years.
In 2011, airline stocks suffered a huge 45% drop. And while they ended up recovering and running higher, they spent more than 15 months trading sideways. They spent more than 15 months "sandpapering" traders who bought right after the drop. Then in late 2012, airline stocks started moving higher. You can see that sandpaper phase in the chart of leading airline Southwest Airlines.
Again, sandpapering after the guillotine strike is usually how the market works. It takes time to absorb the shock of lower prices and form a bottom.
And since many folks are still bullish on oil stocks today, we believe they'll trade sideways (or even lower) for at least several months. It could take more than a year for the sector to digest its huge recent loss... and frustrate the people who just bought shares.
You can see the guillotine in this two-year chart of the Dow Jones U.S. Oil & Gas stock index...
Now that oil stocks have suffered the guillotine strike, expect a sandpaper phase. The vast new supply of oil from North American fracking should keep prices below $60 for years.
These lower prices will start filtering through oil-company income statements and balance sheets. Companies will report much lower asset values. They'll start reporting shockingly low earnings. Some of the companies that have taken on lots of debt will go bankrupt. We're sure a few companies will be busted for questionable accounting and overstating reserves (it always happens after major tops).
There will be a relentless supply of bad news from this sector... which will keep the investment public away.
Of course, we can't know how long the oil sector will take to frustrate the people who just bought in. But it's likely to be at least six months. We're sure experienced short-term traders (like our friend and colleague Jeff Clark) will be able to trade short-term rallies. But for traders and investors with longer time horizons, it's best to avoid oil stocks right now. They're due for a sandpaper phase.
When oil stocks finally rally, the gains could be enormous. But it's best to stand aside right now. We're monitoring the sector closely... And we'll update you as it plays out.
But for now, we'd much rather focus on sectors that will benefit from consumers paying less for gasoline... Stay tuned for more on this idea.
Regards,
Brian Hunt and Ben Morris
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