While bullish sentiment data lingering in the 50-65% zone for much of 2019 would suggest otherwise, oil (USO) was one of the best-performing assets last year. Not only did oil manage to outperform the S&P-500 (SPY), but it also edged past returns for gold (GLD) and the Renaissance IPO ETF (IPO). Since the commodity’s test of critical support at $52.40 in October, oil has been on a runaway rally, up 10 of the past 13 weeks. However, the commodity now faces its first real test in several months, which is overhead resistance at the $65.10 level. If the bulls can breach this level on a monthly close, the commodity will finally swing back to bullish across all time-frames.

(Source: TC2000.com, Seeking Alpha Premium)

(Source: TC2000.com)

Despite it being a dismal year for most oil stocks, oil managed to put up a tremendous return and has started out 2020 on the right foot as well. A good chunk of this strength out of the gate in 2020 comes after the U.S. Airstrike in Baghdad early Friday, targeting the head of Iran’s Elite Quds military force. While it’s unclear whether we’ll see escalation following this attack, oil prices seem to be betting on that possibility, up 3% Friday alone. Despite this push higher for oil, bullish sentiment inched up only a few points, finishing the week at a reading of 78% bulls. This is a significant increase from the apathetic sentiment readings this summer but is still shy of what I would consider being an exuberant reading. Let’s take a closer look below:

As we can see from the chart below, bullish sentiment for crude oil traded in a relatively tight range for the back half of 2019, bouncing around between the 35% and 70% level for bullish sentiment. However, despite a more than 25% rally in three months, sentiment levels are still not knocking on the door of complacency, which suggests a somewhat irrational distaste for what’s been a top-performing asset.

To put this in context, bullish sentiment for silver launched from 50% bulls to 96% bulls in a matter of weeks from June to August, following a similar advance of 25%. While this doesn’t mean that oil has to head higher from here, it does suggest that any sharp pullbacks of 7% – 10% are likely to get bought. This is because oil has not become anywhere near a crowded trade yet on an intermediate basis.

Oil Sentiment

(Source: Daily Sentiment Index Data, Author’s Chart)

Silver Sentiment

(Source: Daily Sentiment Index Data, Author’s Chart)

If we move over to a bigger picture look at oil, the monthly chart supports this view as well, with oil finally reclaiming its 20-month moving average (teal line). This is a significant development for the bulls, as the 20-month moving average has been a ceiling for over a year now, with rallies running into immediate selling pressure. Not only did the commodity have trouble here in April, but also in September, despite the drone attacks on the Saudi Aramco production plants. Therefore, the fact that the commodity has finally pushed above this level and is showing follow-through is an intermediate-term bullish sign for the bulls, as it suggests clear signs of a change in character.

(Source: TC2000.com)

Taking a look at a breadth chart of oil stocks below, we also see some confirmation of this change of character in oil. As we can see, the percent of Oil & Gas Exploration/Production stocks above their 200-day moving averages has risen above the 50% level as of Friday’s close, a significant bullish development. Despite lower lows in the Oil/Gas Exploration & Production ETF (XOP) since June, this breadth indicator has continued to make higher lows and higher highs, a positive sign. Ideally, the bulls are going to want to see the bulls defend any dips below the 50% level going forward. This would confirm the change of character among oil stocks, which is emboldening the thesis of a bullish character change in oil on its intermediate time-frame.

(Source: Author’s Chart & Data)

Finally, zooming into a daily chart for oil, we can see that the commodity has just registered a golden cross, which is when the 50-day moving averages crosses back above the 200-day moving average. The good news is that this one looks like it has a good chance of sticking. While oil registered similar golden crosses on May 7th and August 26th, both of these occurred with the 200-day moving average (yellow line) in a downtrend. Therefore, these golden crosses were less reliable as the commodity itself needed more time to build out a constructive base. The current golden cross, however, is occurring above a solidly rising 200-day moving average, with the 200-day moving average in an uptrend for over a month now.

(Source: TC2000.com)

So is there any bad news?

The only negative news for the bulls here is that strong resistance looms overhead at the $65.10 level, and this has been a tricky spot for the bulls to get through the past year. Based on oil being within a stone’s throw of this resistance, I do not believe this is a time to be starting new long positions in oil given the current reward to risk. The fact that oil is nearing resistance does not mean that oil is a short at current levels; it merely means that there are much better spots to look at adding exposure. The first logical spot to add exposure would be closer to the upper support level at $57.15 if we do see any pullbacks in Q1. As long as this $57.15 level is defended on a weekly close, all pullbacks can be considered as noise.

(Source: TC2000.com)

To summarize, oil continues to improve across all time-frames, and this is being confirmed by breadth improvements in oil stocks as well. The fact that the recent 25% rally in oil has been met with minimal exuberance is a positive sign on a medium-term basis (3-6 months), as it suggests that any sharp pullbacks of 7-10% have a good shot at being buying opportunities.

Based on this, I believe any corrections to the $57.15 – $58.50 level would provide an excellent opportunity to begin to add exposure to both oil and oil stocks.

However, it’s imperative to focus on the leaders among the oil stocks, with Philips 66 (PSX) being one of the ideal candidates.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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2020-01-05