Seasonal Sector Trades: Looking for a Crude Oil Bottom

By: Jeffrey A. Hirsch & Christopher Mistal

January 13, 2015

Crude oil has a tendency to bottom in mid-February and then rally through July (highlighted in yellow in second chart below). It is that early February low that can give traders an edge by buying ahead of a seasonally strong period. Going long crude oil’s July contract on or about February 13 and holding for approximately 60 days has been a profitable trade 25 times in 31 years for an 80.6% win ratio with a cumulative profit of $91,890 (based upon a single futures contract excluding commissions and taxes).

[February Long Crude Oil (July) Trade History]

Crude oil’s seasonal tendency to move higher in this time period is partly due to continuing demand for heating oil and diesel fuel in the northern states and partly due to the shutdown of refinery operations in order to switch production facilities from producing heating oil to reformulated unleaded gasoline in anticipation of heavy demand for the upcoming summer driving season. This has refiners buying crude oil in order to ramp up production for gasoline. In recent years, crude has been finding a bottom earlier. Last year, crude was weak the first three weeks of the year before rallying from around $90 per barrel to nearly $108 by mid-June.

[Crude Oil (CL) Weekly Bars (Pit Plus Electronic) and Seasonal Pattern]

In early December, as crude oil’s decline was accelerating, we threw our hat into the “where’s crude headed” ring. The conclusion was a seemingly ridiculous price right around $40/per with some rather basic supporting math to get to this price. As of today, the front-month February crude oil futures contract traded as low as $44.20. The velocity of crude’s decline has caught many off-guard, us included. Although, the current assessment of medium to longer-term supply/demand fundamentals does paint a gloomy outlook for oil bulls, the recent sharp move lower does seem excessive. OPEC has not blinked, nor have U.S. suppliers, but sooner or later someone will and the current excess supply on the global market will be reduced or even vanish.

With an oil-company-related holding SPDR Energy (XLE) already in the Almanac Investor ETF Portfolio, we will look to expand our holdings through the use of a crude oil futures-based ETF. United States Oil (USO) is the largest and most liquid of the futures-backed ETFs. It trades in excess of 15 million shares daily and has net assets exceeding $1 billion. USO is off nearly 60% from its 52-week high reached last year in June. Its stochastic, relative strength and MACD indicators are deeply into oversold territory. USO can be purchased on dips below $17.00. Due to crude oil’s recent trading action, we will look to build a position. This first trade will represent the first third of the total position.

[United States Oil (USO) Daily Bar Chart]