Crude Approaches $90 a Barrel - Do I Hear $100?

Includes: IEZ, SUN, TSO, UGA, VLO, XLE
by: Jim Farrish

We have all watched the price of crude rise from its low of $34.29 in February 2009 to yesterday’s close of $89.38. It is now at the $90 mark, with some analysts believing it will eclipse the $100 level before year's end. The weekly chart of crude below shows the rise within the upward-trending trading range. The break above $87.10 was bullish and opens the way to the top end of the range and the next resistance near the $100 mark. As investors, this has multiple implications to both our portfolio and the world's economics.

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Starting with our portfolio, we should be overweight to energy stocks and oil. Energy currently accounts for 11.9% of the S&P 500 index. The weekly chart below is SPDR Select Energy ETF (NYSEARCA:XLE). As you can see, the climb higher has accelerated since the August low near $50. The driver has been higher prices for crude. Since the S&P 500 is a large-cap index, the ETF is dominated by the large-cap conglomerates such as Exxon-Mobil (NYSE:XOM), Chevron (NYSE:CVX) and Conoco Phillips (NYSE:COP). The large-cap oil equipment and services stocks are well represented as well with Halliburton (NYSE:HAL) and Schlumberger (NYSE:SLB). The simple play for most investors would be an allocation to this type of fund.

The oil equipment and services stocks have been the leader within the sector. Keeping with the same weekly charts, iShares Equipment & Oil Services ETF (NYSEARCA:IEZ) below shows the acceleration since the low in August. The break above resistance near $50 was bullish short-term for the sector. However, there is some potential resistance at $55.40 to watch. If crude continues higher, the likely progress is the same for the sector.

The refiners have been another component of the sector moving progressively higher. Looking at charts of Valero (NYSE:VLO), Sunoco (NYSE:SUN) and Tesoro (NYSE:TSO) show gains in excess of 40% since the August lows. Why? Gasoline (NYSEARCA:UGA) has made a move from $30.35 in August to $40.41 currently. Demand for gasoline has risen in the U.S. over the last month, and is expected to continue to rise modestly with the slowly improving economy. The same is happening in China and India. The demand for crude is moving modestly higher and the production has slowed. Remember: Almost a year ago, Valero shuttered three refineries in the U.S. Bringing those back online could take up to six months. In addition, OPEC has stated that it has no intention of increasing the supply of crude oil in the near term. While the gains in demand are modest, the impact on the energy sector has been substantial, due to the surrounding circumstances and a good dose of speculation.

Taking all of this into account, are oil and energy still valid investments, considering the gains? I would have to answer "yes" to that question at this time. The breakthrough and above-key resistance points on virtually every chart validate investor demand. Momentum is with the sector and, for the forseeable future, being overweight energy may be the only way to afford the increase in gasoline prices at the pump.

The second part of this equation to consider is the global economic impact. If oil moves back above the $100 level based on demand, price inflation in goods and services will be the result. The Federal Reserve may get its wish for inflation, the challenge being that it will come in a format the Fed cannot adjust for with interest rates. Rising energy costs come with a price, which ultimately filters down to the consumer paying that price in higher costs. This is something to watch moving forward. The higher crude rises, the more negative pressure it will put on an already struggling global economy.

Disclosures: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Our corporation is currently long in IEZ and TSO.