Is Oil Offering A Generational Opportunity In Energy Or Is It A Value Trap?

At first glance oil has offered a very rare 33% decline from highs. But is it cheap or starting a very serious bear market? Afterall, the high oil prices of the past has caused serious research in investment of natural gas, solar, wind power and various fuel cell technology and alternative fossil fuels. China years ago had created a declaration and plans to become energy independent by 2020 on the backs of solar technology research. The US has had some costly failures of investment in solindra and other failed solar projects however as oil got really expensive suddenly hydraulic fracturing or "fracking" was a new innovative way to acquire shale oil. Several new exploration and discoveries put US on pace to be the #1 energy producer in the world by 2015 at the rate things were going. However, no trend is forever. While companies compete to get more oil to the masses, other companies must lower prices to attract buyers. As people are less dependent upon oil the demand is lessened even as the supply increases. Additionally, the oil nations of OPEC undoubtedly know that a lot of these new young companies are not profitable if oil goes below $70 per barrel and such a drop could temporarily take out their competition and allow them to grab more market share and increase the prices in the future. A short term loss may open doors for longer term gains, so it is possible that the oil nations would sell at a loss in order to be able to maintain their oil empire for as long as possible.
However, sanctions on Russia as well as a strong dollar have also contributed to oils decline and the result of this economic pressure and hardliner approach to Russia could actually be fire met with more fire and international conflict which although may be bullish for oil in some circumstances, may actually result in a flight of capital into the dollar and oil could go down even as supply potentially may be tightened.

I'm not the best macroeconomist/analyst in the world so instead I will refocus what I do know. Psychology.

Anytime demannd gets "top heavy" or a lot of people paid higher prices and are now wrong, and a lot of people that shorted at higher prices are now right with relatively small amounts of transactions taking place lower, you have a natural psychological bias for markets to go lower. Those long are either forced (through margin calls and deleveraging) to sell, or through fear are psychologically more likely to be geared to sell. In the event that prices drift higher you have a lot of longs who are happy to get back close to even and a lot of short positions that are happy to re-initiate at their initial price points. This isn't always the case but the natural psychological bias plus fewer people in the opposite position mean the odds are in the bears favor (fewer people who own from lower or shorted from lower and now are likely to defend their longs by buying a dip and are less anxious to close their longs on a rally). Even if 60% of the people underwater were more likely to close out a rally than buy a decline and 60% of the people in positive equity were more likely to add on dips than sell on rips you still have a clear numbers issue where a lot more people are either buyers from above under water or short from above in positive equity than those positive equity from below or underwater on shorts from below. In most markets this naturally with all things being equal cause markets to drift LOWER and require a disproportional amount of NEW buying demand than selling supply to even allow the security to hold ground.

Since commodities like oil are heavily used to power business and to generate heat and create gasoline to power cars there may be a bit less psychology involved, but keep in mind that many of the businesses still create hedges using futures, still are emotional, and still must adhere to risk management principals. Since oil futures create leveratge, they are just as susceptible to DELEVERAGING when they end up underwater and are FORCED to sell or should sell to avoid being forced to sell in anticipation of lower prices.
But it could very well be that commodities are heavily tied to the dollar and the decline in oil is less about actual price behavior and more about currencies. If that is the case we should see oil look bullish in other commodities. In other words, the decline of another currency should outweigh the decline of the price of oil. That would mean that the rise in the dollar created the lower prices more so than the fundamentals of supply and demand of oil itself. By mapping out the price of oil divided by currency ETFs we can determine if there is anything bullish about oil priced in other currencies. An equal or higher high, a series of equal or higher lows or something to indicate strength. But we can see that is not the case.

That may not rule out the possibility that initially the strength of the dollar created forced selling which lead to further losses, but we cannot prove that and even if that was the case there should at least be something to indicate new buying and it should show up in less of a global rotation away from oil. Instead even as the dollar gets stronger, oil should weaken at a lesser rate than the currencies weakening vs the dollar. That is not happening. Only the Canadian dollar and Australian dollar really have any hope in a strong immediate bounce of turning bullish and that is only based upon reading sentiment. The yen may not have broken near its all time lows but it clearly is breaking below recent lows and has a long ways to fall before it appears to have support. The only silver lining in oil is the intensely oversold condition that can be seen in virtually all currencies on both daily and weekly charts. However, to reiterate the volume profile is such that eventually the bounce likely will be sold into and we are far enough below the reference point where a bounce above $95 in light, sweet crude futures for the bulls to regain control is unlikely.

Although it can be tempting to buy energy with it so badly oversold and I initially bought some CHK at $19 with the intention of making it a longer term hold, upon closer analysis it makes sense to wait a little longer to see if we can get some strength at least in oil relative to SOME currencies or an even more dramatically oversold state plus a lot of volume indicating capitulation and potentially creating a new reference point, so I sold it near $24 and turned it into a trade.

Eventually, energy may provide a generational buy opportunity but for now I would remain very patient. If you must indulge either create a situation with a manageable trade risk management near a recent low (whether you are looking for a quick trade or long term hold as long as the low isn't breached), OR initiate a much lighter position with plans to add and be very patient about adding just yet.

That does not mean it may not be useful to watch this area more regularly and get used to watching how some of these names trade so that your eyes are open to opportunity later on. Just because there may be lower prices in oil don't mean that individual oil stocks may have already priced in Armageddon in oil prices and may rally in anticipation of an eventual bottom in oil well before it happens. So it may still be worth watching the oil drilling/explorers, the oil services and independent oil+gas industries for those that have time.