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Earlier this morning, Keith shorted the XLE in our virtual portfolio.  We’ve outlined the chart of this etf below, but suffice it to say oil, the commodity, and oil producers, as represented in the XLE, are broken.  The key drivers behind this breakdown are the inverse correlations with the U.S. dollar, an ongoing slowdown in China, and burgeoning inventories globally.

Two days ago we wrote a note titled, “Oil is Broken”, and we noted:

“As we discussed ad nausea last year, the direction of the price of the U.S. dollar is critical for determining the price of those commodities priced in dollars.  In the year to date, the U.S. Dollar Index is up ~0.74% and, not surprisingly, Oil is down ~-6.61%.  While last year the inverse correlation was more like 4.5:1, early on this year it seems like that factor is accelerating.  One driver of this is likely the slowdown occurring sequentially in China.”

As the Chinese proactively slow their economy in the first half of this year via lending restrictions and higher interest rates, it will continue to have a negative impact on the demand side of the equation for commodities and primarily oil and copper.  China is the world’s GDP market share taker and as its growth slows, even on the margin, it has an amplified impact on the demand for commodities, which is negative for price in the intermediate term.

On January 27th the DOE reported inventory numbers for oil and oil products.  While oil actually showed a draw of 3.9 million barrels, which is bullish on face value, this was quickly attributed to weather issues in the Gulf of Mexico.  Most disturbing for those bullish of oil were the build in inventories of both gasoline and distillates, which suggest a soft demand situation in the United States, the world’s largest user of petroleum.

The chart of the XLE and its key levels is outlined below.

Daryl G. Jones

Managing Director

Shorting Oil - xle29