Chesapeake: Boom Or Bust? Decision Time.

| About: Chesapeake Energy (CHK)
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Summary

Bull or bear, boom or bust? There are plenty arguments on both sides.

We can put our bias and view of fundamentals to one side for now.

CHK has been here before. The recovery from a crash is taking a familiar shape.

It provides a guide to possible price action for the rest of year.

Chesapeake Energy (NYSE:CHK) has been pulled down again by its correlation to natural gas (NYSEARCA:UNG) and oil (NYSEARCA:USO).

As it rests once again on critical $4.9 - $5 support, we are faced with a critical question: boom or bust?

To answer this question I will look at what drives the CHK stock price, and draw on real life examples of what CHK has done before in a very similar position.

Background

I recommended buying CHK at the March 8th low and sell at the April highs.

These trades were based on CHK's relation to natural gas and used technical analysis to time the entries and exits.

I said on April 6th,

if you are looking to buy CHK, I would suggest to wait until a pullback in both gas and CHK and let the odds swing in your favor again.

Are the odds now in our favor?

Fundamentals

I follow the CHK 'story', but I do not pore over its earnings and the complexities of its debt structure as over the medium to longer term, CHK simply follows natural gas.

software developed by Arbitrage Trader

The chart above shows how a beta adjusted portfolio of CHK performs against UNG over the last 200 sessions. Despite earnings, events, and unique CHK fundamentals there is little difference.

The reasons for the correlation are fairly obvious, but nevertheless it is surprising how closely linked the price moves have become. CHK is, after all, also reliant on oil, and 70% of 2017 gas production is hedged.

The 600 session view shows the same relation.

I'm merely showing this to explain why I am spending little time analyzing CHK's fundamentals. I am bullish natural gas and oil for fundamental and technical reasons and this is enough for me.

Reasons to buy CHK

As much as gas and CHK move together over the medium term, there can be short term divergences due to company specific reasons and these can take price quite a distance before snapping back.

In other words, just because I believe gas will reverse higher in the next few weeks doesn't mean CHK will follow straight away and this could cause a lot of short term pain.

I need a reason to buy at $4.9, and I believe the chart below provides one.

I have been using this comparison for over a year now and the price action is actually getting more and more similar. The conditions and concerns after a crash are very similar and this leads to comparable price action during the rebound.

This is how I described the comparison of the recoveries back in my March article:

Both recovery rallies took around a year, formed a channel and found support on the 200dma. When the 200dma and channel broke in early 2010 - as it did in early 2017 - price declined to the 50% retrace of the former rally.

We can see from the very first chart in this article how the 50% retrace acted as support as I suggested it would. After a decent bounce price has now returned there. This is exactly what happened in 2010 and this level was the springboard for a rally to new highs. I expect the same to happen again.

Oil provides a good example of the method I am using. The below chart comes from one of my March articles showing the comparison in price action after the last two 78% declines.

Despite all the differences in the world in 2009 and 2016, the recoveries are nearly identical, from seasonality to price structures.

Soon after the publication of this chart oil declined to a May low as suggested.

If the similarity continues the path for oil is now higher and this will help CHK.

Conclusions

CHK is hovering on support and could either break down or start a new rally. Boom or bust? I say boom for several reasons.

Firstly, I am bullish on oil and gas. They have made constructive pullbacks and are both fundamentally and technically bullish. Rallies in these commodities will pull CHK higher.

Secondly, I have been closely following CHK's recovery and relating it to the last time it recovered from a bear market. The price action is very similar and it suggests the 50% retrace will hold and lead to a rally to new highs later in the year.

Disclosure: I am/we are long CHK.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.