Gold and Oil Stocks

The ratio of Oil Stocks to Current Oil Prices has been a good predictor of short-term stock market performance. What message does it have in store for us now?

This market has something for everyone.

If you’re a Bull, then there is ample reason to believe stocks will soon be blasting higher. If the sub-prime disaster cannot pull stocks much lower than what will?

If you’re a bear, you would be considering the recent volatility as an opening salvo in an ongoing Bear market.

So which is it?

Bull, Bear or perhaps neither but a prolonged range bound market to frustrate everyone.

In July we published an article called Oil Stocks lagging Current Crude Oil Prices where we explained that the ratio of Oil Stocks to Crude Oil was a useful gauge for the future direction of the stock market. The rationale being that Big Oil Companies are major components of the S&P500 and the Dow Industrials. And as such their movements are more in synch with Large Caps than with changes to the price of Crude Oil.

Chart 1 Oil Stocks: Crude Oil ratio as a predictor of the Dow Industrials

This hypothesis has worked well so far. When we last highlighted this ratio it had broken support (lower green line) but the stock market had yet to sell-off (blue line) but it subsequently did.

Current interpretation: The subsequent rebound in the ratio (after breaking support) is typical technical action. After a breakdown, price usually comes back to test prior support which is now resistance. Whether this is the case here or whether the break was a fake out remains to be seen. If indeed the break is real (we suspect it was) then the ratio will retreat to around 15.5 and the Stock Market will follow lower (perhaps after a small time lag of a week or 2). In other words, the Bears will have the day!

The only thing that troubles us about the above analysis is that both Oil and Oil Stocks look so damn bullish:

Chart 2 - Oil Stocks and Crude Oil breaking out of Reverse H&S formation

Both Crude Oil (blue line) and Oil Stocks have recently broken out of reverse Head and Shoulders patterns and it is difficult to conceive of the market falling apart whilst Oil Stocks charge ahead (even if they do lag Crude).

Interestingly enough, the targets for the above patterns are the old July high for Crude but not quite that high for the Oil Stocks (1431). Thus ensuring the ratio (bottom of chart in red) will continue to move lower.

As we said, this market has something for everyone!

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