Thursday, June 26, 2008

Have oil stocks exhausted their run?

Floyd Norris, the chief financial correspondent of The New York Times, suggested in his blog today that we are looking at "The Beginning of the End for High Oil Prices". What is the basis of his optimism? He argued that oil stocks have been lagging oil prices lately, and therefore equity investors must believe that high oil prices are causing demand destruction which will eventually reduce oil prices and oil companies earnings.

I beg to differ.

Look at the long-standing spread relation between an oil stock ETF and an oil commodity ETF, e.g. XLE vs USO, which I have been commenting on and tracking since October 2006. At the moment, this spread is within 1.4 standard deviations of its historical value. See my table here (subscription required). In other words, oil prices and oil stock prices are at approximately their long-time historical average. I would hardly call that suggestive of the beginning of the end.


chrispycrunch said...

I've been following the energy stocks from a technical perspective. There is a risk for them correcting significantly, but intermediate/long term I think that high energy prices are here to stay.

Max Dama said...

Hi Ernie,

I've been watching the two indexes diverge further since the 26th. What do you think is a significant spread in terms of SDs and based on your data what is the spread now? I'm a student of StatArb.


Ernie Chan said...

Hi Max,
The USO-XLE spread is at about 1.81 standard deviation now. It has certainly become wider since the 26th, but not unusual for this very non-gaussian spread.

Max Dama said...

What would you consider significant?

Ernie Chan said...

For this pair, 4 or even 6 standard deviations out are not unheard of.