Oil has entered a "Twilight Zone" where rumors and financial moves in outer markets affect oil-company stocks and crude prices, making trading these markets not only difficult to navigate but outright dangerous. So, we've got to stay disciplined and focused, staying away from some tempting but ultimately destructive "opportunities."
Oil has put together a strong rally recently, pushing Brent prices back above $50 a barrel. But smart investors must analyze where this move comes from:
A Looming Oil Producers' Summit
The Organization of Petroleum Exporting Countries has tentatively set a September meeting with non-OPEC countries to once again discuss production cuts.
Saudi sources and Russian Energy Minister Alexander Novak have both floated the idea that some positive outcomes might come from these discussions. For example, Saudi Energy chief Khalid Al-Falih has said his country would "take any action to help the market rebalance."
However, the Saudis have pushed August production to 10.9 million barrels a day -- the highest level ever. That kind of aggressive move ahead of meetings signals that an agreement seems very unlikely. It also indicates that the Saudis (as well as the Iranians) are continuing to fight for market share rather than getting ready to compromise on production limits.
Don't get me wrong, I see a reconstitution of OPEC as the oil supply's global gatekeeper as very much in the cards -- eventually. In fact, I believe that's the Saudis' end game to their two-year assault on U.S. and other non-OPEC producers.
But such a production agreement will likely only come once OPEC has driven U.S. and other non-OPEC producers completely into the dust without a hope of ever arising again, and we're not nearly at that point yet. Look at Chesapeake Energy (CHK) , a company I long ago put on my list of the "walking dead." It was by far the most likely large-cap U.S. production name to go bankrupt, with a debt-to-equity ratio above 4,000!
Frankly, we need to see firms like CHK collapse before we can believe that U.S. oil production's destruction is nearing its apex and that crude is truly on the road to a complete rebalancing. But Chesapeake has yet to go under -- in fact, the company recently announced $1 billion in new funding from Citigroup (C) and Goldman Sachs (GS) .
Coupled with oil prices' recent rebound, the new funding helped CHK's shares rally by more than 25% over the past month. The hope is that fresh financing will allow Chesapeake to live to see $80-a-barrel oil some day.
But that's the exact outcome that the Saudis have been trying to prevent, and I expect they will ultimately prevent it by not signing any production limits -- yet.
A Weaker Dollar?
Meanwhile, the U.S. Dollar Index is finally showing some longer-term weakness, indicating that perhaps we've seen the greenback's highs for now -- and with them, oil's near-term lows. This has again sent hedge funds and other speculative players trimming shorts and increasing longs in the oil market, which has helped send crude prices higher.
But none of this is fundamentally based. In fact, oil stockpiles remain hugely oversupplied, and even bankrupt oil companies continue to pump out crude to satisfy bondholders. At the same time, huge amounts of investor and private-equity money continue to chase "five-bagger" opportunities like Chesapeake.
The Bottom Line
Add it all up and I don't think it's time to chase oil stocks yet. Instead, I've been using the recent rally to take profits on winners that I accumulated earlier this year.
For example, I've sold more than half of my holdings in EOG Resources (EOG) after the firm's mega-positive report send shares above $91 from my cost basis around $72. Similarly, I've shaved my holdings of Cimarex (XEC) and Hess (HES) . All of these have been huge winners since I accumulated them this spring.
Until U.S. oil production's destruction is complete -- a process that has admittedly taken longer than I expected -- I foresee better opportunities down the road to buy quality energy stocks at value prices. So for now, I won't let financial rallies or OPEC rumors tempt me into getting into the sector at current prices. Instead, I'd rather be getting out.