There will be blood

First of all, I was very, very lucky to get out of AGN.

Now the key question is: what is going on with oil/coal/natural gas?
Put differently, is this a fundamental or a technical change? Because it makes a difference.
A technical sell-off could be triggered by a few factors, like:
1. It was irrationally driven up
2. Falling prices triggered trading programs to sell, and thereby lock in profits
3. Banks and funds need cash, and there has been a good run in these sectors
4. The end of a short squeeze. What if the prior 1 month of oil price run-up was driven largely by companies having to cover short positions in oil? They finished and so demand for oil contracts is down.
5. Volatility of earnings season and options expiration week
6. Earnings season has begun – a lot of volatility
7. Fed reporting has begun – Bernanke’s Congressional presentation (the economy looks like it’s worse) plus GDP figures, monthly economic indicators for June and so forth
8. Oil as a dollar hedge – Inflation and a weak dollar drove folks to oil. The dollar has firmed somewhat and inflation came in moderate (if we’re only talking core CPI).

A fundamental based sell-off could be triggered by:
1. Supply exceeding demand. This week we saw that US supplies were sharply higher than expected. Also, OPEC predicted a slight reduction in global demand next year. The shift was so slight, but just enough to spook the traders. That is very important to note.
2. Overbought stocks. I had been saying that these stocks looked too expensive, and I based that on the relationship to the 50 dma. So when they dipped to the 50dma last week, we moved in. Subsequently they moved up a bit and then went below their 50dma yesterday. Some even went below the 200 dma.

Now look at the volatility for the last 100 days. As the Dow has dropped, volume has surged. (Which is a big, big deal for ETFC – more trading is more revenue, and trades are up 75%). That’s a lot of money moving around.

Lastly, was this limited to oil? In the past 2 months, gold surged 15%, from $850 to $980. In the last week it has drooped 3%. Gold is another hedge against inflation and a weak dollar, and it has not crashed like oil. That suggests a more oil sector specific trend.


TRYING TO MAKE SENSE OF IT ALL
We bought DUG on the premise that oil was over bought and a pullback was in the cards. At the same time, I felt that companies providing oil/coal and providing services/equipment to the energy sector would continue to do well even in a pullback. For example, with so many more drills being operated, they need more equipment and they will continue to have big demand regardless of oil at $145, $130 or 4120.

Instead of jumping in, which is why I waited for a sharp pullback to where the price seemed reasonable. The continued pullback seems overdone relative to their move up and relative to the oil drop that triggered their pullback this week.

Consider Murphy Oil, down 21% in 17 days, and at a 3 month low. All of the energy stocks in our Call positions are at 60 day or 90 day lows. That is, they have fallen back to levels before the oil run.
That tells me that either this was pump-and-dump (my worst fear) or just a panicky run for the exits. Since I have done my due diligence and I am confident that these stocks are seeing accelerating growth, I don’t think a 10% drop in oil prices will change their profitability prospects.

I fall into the category of feeling that this is partly trading (sector rotation to lock in profits) and partly a sign of a panicked market. The market thought things were ok, but then Fannie Mae almost went belly-up and IndyMac did. And then Bernanke came clean and admitted that the economy is hosed.

I do think that these stocks will come out with great earnings and upward guidance and they will move again.
However, after reviewing the chart on volatility and experiencing it the last week, I am of the opinion that I need to do a lot more in-and-out trades. More short term moves and less long term moves.

I may sell DUG sooner rather than later.

Also, it looks like March all over again. We may have to wait a while for the soundness of my stock picking to be reflected in the options.