Technical analysis toolkit for energy investors: Clive Maund

Clive Maund: The charts do factor in periodic crises that impact oil and gas prices as buy and sell moments, but often in a contrary way. The trick is to gauge when a crisis is at its moment of greatest tension, and while this is not at all easy, the charts can often be a great help in defining such a moment. I will give you an example using a recent call on CliveMaund.com, where the top in oil was pinpointed a day after its occurrence. Some readers may remember an old saying used on the London market many years ago, “Buy on a strike.” This refers to a strike by labor, not an oil strike. The underlying psychology of this was that the time of maximum tension and uncertainty, which was when labor unions called the workers out on strike, was the best time to buy stocks, because they would have been falling in anticipation of this, and as tensions later eased as the situation headed to resolution, they would rise again. So it is with conflict and tension situations in the Middle East and their impact on the oil markets.

Some weeks ago, before the surprise announcement by Putin and Syria that chemical weapons would be turned over to international regulatory bodies, the oil price suddenly put in a large prominent “shooting star” candlestick as it made a new high for its uptrend, which we read correctly as a topping signal and a sign that the crisis was about to ease. Once it did, as we know, the oil price dropped away. The fact that it put in such a signal before the announcement is an indication that powerful, well-connected people knew that such an announcement was imminent, and traded on it to their advantage, as is so often the case. We observed their boot prints in the sand and judged the situation accordingly—and correctly, as it turned out.

Inflation is not much of a consideration, as it is built into the prices of just about everything. It really only needs to be taken into account when you are looking at long-term charts. For example, if a stock is priced at $30, and it was at the same price 10 years ago, it is clearly worth less in real terms now than it was back then. With regard to junior energy stocks, I do not pay much attention to inflation in making picks, because as I said above, it is a background factor that is already built into their prices. What matters with interest rates is not so much their actual level but their direction—their trend, and their rate of change. Right now we are at a dangerous juncture, with the Fed fumbling its way forward, trying to keep interest rates low and retain what shreds of credibility it has left.

TER: Please explain how quants like yourself use chart patterns to analyze a stock’s trajectory over time. Can you talk about the meaning of some of the basic chart movement metaphors, such as “head and shoulders” and “candlestick”?

CM: Most of the technical indicators that we use to identify good entry or exit points for stocks are based on plain common sense. Thus, a stock that has been sold into the ground, and has then formed a base pattern, is likely to start a new uptrend and recover as the company’s fundamental situation improves. On the other hand, an overvalued stock that is racing away to the upside and way ahead of its moving averages is much more risky and prone to correct.

Support and resistance zones on a chart are related to “congestion zones” where a large amount of stock has traded close to a particular price in the past. The way it works is this: After a run-up in a stock, a large number of traders take profits, believing the stock has done its thing and could reverse. Then, to their chagrin, it breaks out and rallies to a new high. Having missed the move, they resolve to buy it back if it should come back near to the price at which they sold. Their buying potential puts a floor under the price on the next dip, providing support, which can be identified on charts in advance and utilized for timing purchases. It works the same in the other direction: Traders buy a stock in a trading range, expecting it to break out upside and continue higher, but it does the opposite and breaks down. Rattled by this, they resolve to “get out even” if it should rally near the price at which they bought it. Their selling potential caps the next rally, creating resistance, which again can be identified and used for timing purposes by the technical trader.

It usually takes time for a major uptrend in a stock to reverse into a major downtrend. Think of a stock as a heavy locomotive that needs time to stop and reverse direction. This is why after major uptrends, top areas form, which allow time for the so-called smart money to offload their holdings to the “dumb money.” The duration of the top area is of course also related to the fact that a company’s fortune does not usually change from improving to deteriorating overnight; it is generally a slow process. The smart money uses the cover of glowing news reports and company statements to offload their holdings at top dollar, aware that the good times are going to come to an end.

Such large top patterns can take various forms. One classic form is the dome, where the uptrend decelerates steadily, finally peaks and then starts down again, slowly at first but then accelerating to the downside. These domes are generally parabolic, reflecting the ebb and flow of sentiment. The head-and-shoulders, which is very common, is actually an irregular form of dome top. The rising wedge can be very treacherous for novice traders, who do not recognize that an uptrend channel that is converging is actually petering out—losing upside momentum as buying power fizzles out. When these patterns break down, the result is often a vicious plunge that can devastate investors who don’t see it coming. We spotted this pattern before silver crashed in September 2011 and positioned ourselves accordingly.

Triangles can take three forms: symmetrical, ascending or descending. With a symmetrical triangle, the top line is falling and the bottom line is rising, usually at about the same rate. The symmetrical triangle indicates a market in a state of indecision, and while it is impossible to accurately predict the direction of breakout, it is usually in the direction of the trend preceding the triangle. The “fish head,” a term I invented, is a type of symmetrical triangle, where the oscillations decrease more rapidly than usual, resulting in a curved top and bottom line—its meaning is similar to the normal symmetrical triangle, the chief difference being that the point of indecision is arrived at more quickly, leading to a more rapid breakout.

[Below: Symmetrical triangle formation]

An ascending triangle has a flat top line, with the bottom line rising. [See chart below] A flat bottom line with the top line falling characterizes a descending triangle. The ascending triangle is bullish as it indicates a situation where buyers are raising their bids. The descending triangle is bearish as is shows that sellers are dropping the price at which they are willing to bail out.

Below: Ascending triangle formation.

Candlestick charting is a fascinating and rewarding aspect of technical analysis, which is based on the fact that price action during an individual day, or a small number of days together, can provide valuable insight into the probable impending direction of a stock. As I said earlier, we used candlestick charting to predict the direction of the oil price before the chemical weapons announcement a few weeks back [see below chart]. In candlestick charting, the relative positions of the open, close and intraday highs and lows of a stock or security on a given day or cluster of days are important factors in determining what is likely to happen next.

[Below: Candlestick formation indicated likely oil price topping point in late September of this year.]

All these charting techniques enable careful investors to stack the odds in their favor and assist investors in determining when a commodity or stock is at or close to the extreme end of a move and likely to reverse direction or embark on a new trend.

Chart interpretation is an art, not a science, and partly subjective, being based on experience. The emphasis is on being right most of the time, not all of the time (that is impossible), and on limiting damage where judgement proves to be incorrect. The effective use of charts involves determining the probability of envisaged scenarios coming to pass. This does not, however, prevent it from being highly efficacious in many instances. A good example is shown below, where it was determined in July 2008 that oil was set up for a brutal take down, as subsequently proved to be the case:

[Below: Before and after charts of the July 2008 oil price drop, which Maund foresaw through his analysis of 50- and 200-day moving averages.]

TER: How does the domination of the Middle East by a handful of countries and corporations affect the movement of energy prices?

CM: While big energy companies may be behind wars of acquisition so that they can gain control of oil-rich regions, once they are in and established they generally want stability so that they can get on and pump the oil without interruption to maximize their profits. While price spikes caused by the threats of unrest and war may produce a welcome boost to profits, actual wars that cause destruction of their facilities and disruption of production are not beneficial.

The control of large areas by the majors results in stability, the sort that we have seen in Saudi Arabia for many decades, for example. But the danger with these mega corporations controlling countries and regions, often in bi-lateral arrangements with local governments, is that giant cartels are created that result in price fixing. So we can say that the advantage of the Middle East being in effect controlled by a handful of western mega corporations is price stability and a tendency to political stability, while the disadvantage is the potential for these stable prices to be on the high side, which is of benefit to the junior companies as well. The junior companies might find it hard to get a foothold in such areas, however, because of the dominance of the majors, and are probably better off exploring elsewhere, the exception perhaps being newly opened-up areas like Iraq.

TER: What has been the effect this year of large investment firms covering shorts in the energy markets? Do you have any picks of junior energy firms that might be rebounding?

CM: This has caused a sizeable spike in the price of oil relative to other commodities, and there can be no doubt that Syria had an important role to play in this. However, with Syria apparently cooling, this has opened up downside risk for the sector, because a lot of these large investment firms are now all on one side of the boat. On the other side are the commercials, which are now heavily shorting crude—and they are not renowned for being on the wrong side of the trade. The latestCommitments of Traders (COT) charts for natural gas, on the other hand, look bullish.

There are a few junior energy stocks that look attractive to me at this time, based on their technical picture. The charts indicate that there’s something going on in Anderson Energy Ltd. (AXL:TSX). This stock has been pulverized, dropping from a high at about CA$9 eight years ago to the current very low price of CA$0.15. Aggressive buying caused the price to spike in the middle of the month, but it has since drifted right back again almost to where the spike started. A large bull hammer appeared on September 27, suggesting that it will now start up again. The number of shares in issue is rather large but this is well-factored into the price.

Arcan Resources Ltd. (ARN:TSX.V) staged a powerful, high-volume breakout earlier this month but has since drifted back on declining volume to an attractive entry point, although it could drift a few cents more before turning up. It will need to get above its 200-day moving average before an uptrend can get established, but this could happen quite quickly now. Arcan was trading at more than CA$13/share less than eight years ago, so it’s picking up from a very low level now. The number of shares in issue is an acceptable 97 million (97M).

There’s strong upside volume in Artek Exploration Ltd. (RTK:TSX), which appears to have been consolidating for the past year to date. This strong upside volume has already driven volume indicators sharply to new highs, suggesting that an upside breakout is approaching, which will lead to another significant upleg. Shares in issue are a relatively modest 62M.

Cequence Energy Ltd. (CQE:TSX) appears to be bubbling under before making a move higher. We saw aggressive and persistent buying of the stock during the first half of September on high volume, which drove volume indicators sharply higher, but it has since obligingly drifted back to a very good entry point at the support level on much lighter volume. It has been pretty much downhill all the way for Cequence since it started life back in 2007 at the lofty price of CA$14, but the latest technicals show that it is firing up for a significant rally. The number of shares is on the high side at 210M, but again this is already built into the price

TORC Oil & Gas Ltd. (TOG:TSX) is at a good price here, especially as the volume pattern and volume indicators suggest that it is likely to start an uptrend before much longer. The price has been depressed for several years after falling back from a high over CA$56 in 2008, but recent heavy volume, most of which is upside volume, is a sign that interest is building in this stock. It looks like there is good value here, and the number of shares in issue is an acceptable 91M.

TER: How is the short-term life span of fracked wells affecting stock prices? What is the overall situation for supply and demand in energy markets, worldwide?

CM: We would expect the short-term life span of fracked wells to create a more rapid boom and bust cycle in junior energy stocks, unless a more or less continuous stream of producing wells can be maintained.

The overall supply and demand situation for oil and gas appears to be pretty much in balance, which is why the oil price has been in a trading range for the past two years. We have seen peak oil and the depletion of existing oilfields, but, necessity being the mother of invention as they say, we have also seen ingenious responses to the situation in new ways of looking for oil—for example, a massive field has been found in the Gulf of Mexico using special deep drilling techniques, and we have the polar ice cap melting at the perfect time for exploration to expand there in a big way, although this is not such good news for polar bears, of course.

Oil found in more difficult-to-access places is more expensive, and this is what has encouraged the search for cheaper supplies, resulting in massive discoveries in the U.S. These new supplies look set to take the U.S. toward energy self-sufficiency, which would have been unthinkable just a few short years ago. However, this may also lead to a supply shock that drives prices lower. This is another reason that the bearish-looking oil COT charts are thought to presage a lower price trend, and it is thought that the oil price was given a reprieve in recent months by the Syria crisis. Over a shorter time horizon, traders need to watch out for a slump engendered by rapid economic contraction due to rising interest rates. As we saw in 2008, sometimes macro factors render the fundamentals of the oil industry irrelevant. This might be what the COTs are warning of.

TER: Are energy ETFs a good bet? If so, what kinds?

CM: Energy ETFs are an excellent way to play the energy market. They have three great advantages. One is that the ordinary investor can avoid the possibly cumbersome details involved in trading the actual commodity. The second is that you can also avoid the risk inherent in individual stocks, and the third is that you can make money on the downside, too, by using the inverse ETFs available.

Investors have a choice of leverage with these ETFs. There are straight unleveraged ETFs, which move one-to-one with the underlying commodity or index; twice leveraged, which double your gains if you get the move you are expecting (these are the ones we generally go for); and triple leveraged, which have a high decay factor, due to being “juiced” by options, etc., and therefore should generally only be used by professionals, and even then mainly for hedging, or in rare situations where investors are expecting a big move in a short timeframe.

The following (long) ETFs and ETNs provide a broad choice: First Trust Energy AlphaDEX Fund (FXN:NYSE), Vanguard Energy ETF (VDE:NYSE), iShares S&P Global Energy ETF (IXC:NYSE),iShares Dow Jones U.S. Energy ETF (IYE:NYSE), SPDR S&P Oil & Gas ETF (XOP:NYSE) andPowerShares Dynamic Energy ETF (PXI:NYSE).

In addition, we have the First Trust ISE Revere Natural Gas ETF (FCG:NYSE) and iShares Dow Jones US Oil Equipment & Services ETF (IEZ:NYSE).

Short ETFs and ETNs of note include PowerShares DB Crude Oil Short ETN (SZO:NYSE),PowerShares DB Crude Oil Double Short ETN (DTO:NYSE), ProShares Short Oil & Gas (DDG:NYSE), United States Short Oil Fund (DNO:NYSE) and ProShares Ultrashort DJ-AIG Crude Oil (SCO:NYSE).

TER: Is there an optimum entry point for energy stocks in the foreseeable future?

CM: Although technically still in an uptrend, oil stocks as a group have just stalled at resistance and look vulnerable to reversing to the downside soon, especially if the key support for Texas Light at $102 breaks soon, as looks likely. Light crude looks set to drop further back to the high $90-range soon, especially as its latest COT charts look bearish. Military action against Syria looks to have been put on the back burner for now. While there is some support in the 1350 area on the Amex Oil Index, there exists the risk of a deeper reaction back to the 1200–1230 area, where there is significant support, and this reaction could carry considerably further if we see a sharp rise in interest rates. Here we should note that rising rates would likely be accompanied by rising gold and silver prices, as in the late 1970s.

Having said this, many junior energy plays look strong here and set to rise on their own merits, pretty much regardless of what happens to the sector indices and larger oil stocks.

TER: How do currency fluctuations affect oil and gas prices?

CM: Because oil is priced in petrodollars, the key currency to watch in energy pricing is of course the U.S. dollar. Countries that have threatened to cease selling oil and gas in petrodollars, like Iraq and Libya, have paid a heavy price, so we can assume that the U.S. dollar will remain dominant into the foreseeable future, although some countries, like China, are looking for ways to circumvent it. With the Fed maintaining quantitative easing, the dollar is under increasing threat of losing its value, which means that oil and gas prices must move to compensate for a falling dollar.

TER: Thanks you for speaking with us today, Clive.

CM: My pleasure.

Clive Maund has been president of www.clivemaund.com, a successful resource sector website, since its inception in 2003. He has 30 years’ experience in technical analysis and has worked for banks, commodity brokers and stockbrokers in the City of London. He holds a Diploma in Technical Analysis from the UK Society of Technical Analysts. He lives in southern Chile.

Find out how Maund has used technical analysis to make successful precious metals trades in his interview with The Gold Report.

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