Crude Oil ETF Heating up

03/10/2009 9:53 am EST

Focus: ETFS

Deron Wagner

Founder and Head Portfolio Manager, Morpheus Trading Group

After drifting lower throughout the day, a closing rally enabled stocks to finish with mixed results last Friday (March 6), but the major indices still suffered their fourth straight week of losses. For the day, both the Dow Jones Industrial Average and small-cap Russell 2000 indices gained 0.5%, as the S&P 500 edged 0.1% higher. At the session low, the NASDAQ Composite was off by more than 2%, but the index trimmed its loss to just 0.4%. The S&P Midcap 400 fell 0.7%. Thanks to a bounce in the last 30 minutes of trading, the main stock market indexes closed near the middle of their intraday ranges.

Total volume in the NYSE eased 5%, while volume in the NASDAQ ticked 7% higher. Since the S&P 500 closed with a gain and the NASDAQ settled with a loss, it would have been bullish if NYSE volume had increased and NASDAQ volume had declined. Such a pattern would have favored the bulls, but the NASDAQ registered a bearish "distribution day" instead. Nevertheless, market internals in the NASDAQ were not too bad; declining volume exceeded advancing volume by less than 2 to 1. The NYSE advance/decline volume ratio finished negative, but only marginally.

There are obviously very few opportunities on the long side of the market right now, but several of the energy commodity ETFs may be in play this week. For starters, take a look at the daily chart of the Crude Oil Continuous Futures contract (@QM):

Since peaking approximately eight months ago, crude oil has been in a steady downtrend. However, its daily chart is indicating a potential reversal of its primary trend. Most notably, it has moved above its 50-day MA for the first time since last July, and has not done so in a parabolic way (which would be more likely to fail). Rather, it rallied off its low to form a higher high in late February, pulled back to form a "higher low" on March 2 and 3, and is now breaking out to form its second higher high. As long as the March 3 low is not violated, a new intermediate-term uptrend may be underway.

To take advantage of the developing trend reversal in crude, ETFs to consider are: US Oil Fund (USO), iPath Goldman Sachs Crude (OIL), PowerShares Crude Oil Long (OLO), and PowerShares Crude Oil Double Long (DXO). As one might expect, all four ETFs have essentially the same chart pattern. However, DXO is showing a slight bit of relative strength to the others. Just remember that leveraged ETFs like DXO may not track exactly the same movements as the underlying index. This is due to the use in the daily rebalancing of the derivatives used to achieve the leveraged moves. Again, our view is that leveraged ETFs are fine for short-term trading, but they often underperform in the long-term.

Perhaps even better than the crude oil ETFs is the US Gasoline Fund (UGA). Its daily chart is shown below:

Unlike the crude oil ETFs, UGA has been consolidating above its 50-day moving average for the past two months. In mid-February, UGA had a "shakeout" by dipping below its 50-day moving average for several days, but it quickly rallied back above it. Since then, it has been consolidating in a tight range, and above its 20-day exponential moving average. We're already long UGA from our March 4 entry, when UGA rallied above the upper channel of its four-day "bull flag" pattern. So far, UGA hasn't done much, but its bullish consolidation will be confirmed on a breakout above last week's high. If you're not already long, UGA could now be bought above the $24.00 area. By the way, be sure not to confuse UGA with UNG, which tracks the price of Natural Gas. While the chart of UGA is poised for further upside, UNG is still trading at its low.

Other than cash itself (which is certainly not a bad idea), your best bet for parking cash right now may be select commodity ETFs (precious metals, crude). The inversely correlated, short ETFs will also work, as long as the downtrend persists, but those are not to be undertaken if you don't keep on top of your positions, nor should they be taken with a long-term view, due to declining correlation with increased holding period.

By Deron Wagner of Morpheus Trading Group

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