A long-term energy bull with an excellent record has turned cautious.

On 9-17-05, on the Financial Sense Newshour, during Dr. Duarte's weekly interview, host Jim Puplava, a long term bull on the oil market and a proponent of the Peak Oil theory, who has been right on the money for the entire energy bull market, told me, on the air, that he was starting to have concerns about the state of affairs in the energy sector, and that he was considering starting to lighten up on his energy holdings. To hear the entire interview go to Financial Sense Newshour

Jim's concern is that much of this money has missed a significant amount of the multi-year move in energy and is now seeing an opportunity late in the game.

A World Of Inflection Points

In a sense, the oil markets, might be reaching that point, usually late in the cycle, where a huge move up in prices occurs, right before the final top is made and prices finally fall, usually for a long time. This is known as a blow off, and if it occurs, it could be similar to that epic move in the Internet stocks that occurred in December of 1999, and eventually led to the top of that bull market, becoming the prelude to the bear market that lasted until 2003.

The technical divergences in the energy sector are quite clear on the charts. For example, crude oil futures for October (CLV5) has been falling in price for several weeks, after topping in price just above $70 per barrel.

In contrast, the Amex Oil Index (XOI) has made a series of new highs.

Traditional technical analysis suggests that the price action in commodity stocks, such as those that make up the XOI, are usually a predictor of what's coming in the commodity itself. If that's true, then we could be in for a very dramatic rise in oil prices.

There is another side to the story, though, the economy itself, and the increasing evidence that high oil prices have finally made a dent in consumer spending habits, as gasoline prices rose above $3 per gallon.

Recent consumer confidence numbers, as well as regional reports from Federal Reserve banks have showed a mixed set of data of late, while the housing market, long the engine of the U.S. economy is also starting signs of weakness.

Around the world, the rise in oil prices has also taken its toll. The Indonesian economy is in deep trouble, due to a rapid rise in interest rates as the government defends it currency, the rupiah, from capital flight due to rising budget deficits which in turn have resulted from government subsidies of high oil prices.

In South America, high oil prices are starting to bite, with daily protests, and social disorder now the norm, rather than the exception, in countries such as Bolivia, and Honduras, where high poverty rates have been magnified by rising energy costs.

Exxon Joins The Party

Perhaps the most telling sign that something different is starting to happen, is the action in Exxon Mobil (NYSE:XOM). This is the world's largest oil company, and it has slept through the entire bull market, spending the last several months hugging the price area near $60.

The stock has started to rise lately, as it was upgraded by Deutschebank on September 16 and was given a $75 price target.

What makes this analysis interesting is that Exxon is being upgraded in the midst of a period where its earnings may possibly be hurt by hurricane Katrina. Throughout the entire bull run, Exxon has made money hand over fist and the stock has lagged the rest of the sector.

This suggests that Wall Street is starting to run out of oil stocks to turn bullish on, and is starting to dredge the bottom of the barrel, another sign reminiscent of the Internet bubble days, where concepts were the key, not how much money a company made.

My point is not to beat up on Exxon. It's clearly a well-run oil company that makes money. But, its stock has gone nowhere in the bull market of bull markets in oil, which suggests that if it now joins the party, it could be a sign that we are entering the final stage of that bull market.

The Sweet Spot

Another way to look at the current situation is that oil companies are now in the sweet spot of earnings Nirvana. Oil prices aren't likely to fall to $25, anytime soon, and a fall below $50 is likely, only if the global economy completely collapses.

That means that even if demand falls slightly, because of the high prices that are likely to remain, when compared to historical standards, oil companies are likely to retain huge profit margins for some time.

The question for the market to answer is whether the sweet spot is already priced into current prices, or whether one more, wild run up in prices is on the way due to hot money.

Conclusion

To be sure, nothing is certain in any market, other that they are all guaranteed to fluctuate. I don't know when a top in oil will come, and the action on new hurricane fears is already starting to heat up, which could lead to yet another test of that $70 per barrel area on crude.

But, there are some signs now that the bull market in energy is starting to reach an important, and potentially final, if not dramatic stage.

• A well-respected bull with real money of his own invested in the oil sector for years is turning cautious.
• Hot money is finally coming into energy.
• OPEC is raising production quotas on a regular basis, and prices are not being affected.
• And Wall Street, not known for its altruistic nature toward the retail investor, is turning bullish on Exxon Mobil, the one, big oil stock that has missed most of the party, as a significant technical divergence in the sector is clearly apparent.

Something different is clearly in the air. In other words, it's time to be very cautious in the energy sector.

© 2005 Joe Duarte, M.D.
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