Oil stocks have been hammered especially hard in the recent stock-market correction. With both the general stock markets and price of crude oil falling sharply, the oil stocks didn’t stand a chance. The result of all this carnage is deeply-oversold oil stocks, a fantastic buying opportunity for speculators and investors.
Oil stocks, of course, are in the business of exploring for and producing crude oil. Thus it is not surprising that the price of oil is one of their primary drivers. Higher oil prices make oil more profitable to produce, and the greater an oil company’s profits the higher its stock price will be bid. So oil-stock traders naturally watch the price of oil closely. But provocatively oil shares its primary-driver role.
This sector’s other primary driver is the general stock markets. When the S&P 500 (SPX) is rallying, oil stocks climb in sympathy even if oil happens to be flat. When the SPX falls sharply, oil stocks follow it lower even if oil is rallying. So like most commodities-stock sectors, the fate of the oil stocks is inexorably intertwined with the ongoing fortunes of the general stock markets.
A couple years ago I did a study on the relative influence of oil and the SPX on oil stocks. Both had nearly identical correlation r-squares (nearly 90%) with the flagship XOI oil-stock index between 2003 and early 2008. Sometimes oil was more important, and sometimes the SPX was. But the oil stocks’ performance was the best when both these primary drivers were rising and the worst when both were falling. And often oil prices moved with the SPX as stock-market fortunes influenced commodities traders, something we’ve seen recently as well.
Since April, both crude oil and the general stock markets have suffered through the largest corrections of their cyclical bulls. Seeing both of oil stocks’ primary drivers down hard simultaneously had a devastating impact on oil stocks. Widespread fears, most of which were pretty irrational, drove oil stocks down to unbelievable lows. If you want to buy low, fear is your friend. This week it drove the best oil-stock buying op that we’ve seen in at least a year.
To understand how deeply oversold oil stocks became this week, you have to understand the technical context. I’ve included cyclical-bull charts for oil and the oil stocks, which are quite compelling. A third chart, the SPX…
