For the last six to nine months the energy bull market that started in the Fall of 2020 has stalled out and sputtered into year end. Shares of energy producers (NYSE:XLE) have underperformed indices and energy traders have been unable to break the market to fresh all time highs despite only being a few percentage points away this past Spring.
Shares are currently hovering at or just above 52 week lows on many tickers but as the saying goes - "always darkest before dawn" and the sun may be rising as we speak. Here is the energy bull case going into Q1 2025 and beyond.
Yields - The 10 year US Treasury Note Yield has surged over 100bps in just the last quarter alone. This indicates that long term inflation expectations are now embedded into the bond market. Strangely this has not led to much higher oil prices and a massive divergence has been building over the last several months -
If these jaws snap shut and revert to the historical mean, then we are in for much higher prices as the market catches up to yields. Of course the other side of it is that yields could be lying here and they could "catch down" to crude, however there are several factors why I believe this is not likely to be the case.
The first of which is:
January Effect -
End of year tax loss selling often creates a dynamic known on Wall St. as the "January effect". Stocks that have underperformed are often sold off in late Q4 to offset the FY tax burden which creates a temporary artificial surplus of sellers into year end. When the new year rolls over those sellers are gone and those shares prices often rebound from their artificially oversold conditions as well there being a lack of new sellers in the marketplace.
Additionally many funds who sold near the end of the year simply buy back after the 30 tax lockout window as they may still like those stocks but chose to sell them to offset capital gains. A TON of capital gains are likely to be on the books this year as both the S&P 500 (SPX)(NYSE:SPY) and Nasdaq 100 (NDX)(NYSE:QQQ) have returned nearly 30% YTD so tax loss selling may be incentivized even more than in normal years.
Seasonality -
Energy shares typically stall out in the late Fall/early Winter and dip into the 2nd or 3rd week of December before bottoming for a steep rally that leads into Q1-Q2.
Credit - equityclock.com
WTI futures (CME:/CL) tend to top out in the summer time before bottoming in December as well. The winter bottom then generally leads to a strong Q1/Q2. This is more or less consistent with recent price activity.
Credit - equityclock.com
Dealer Positioning & Sentiment -
Hedge funds & other asset managers are now net short energy shares while dealers (banks) are net long for the first time since Q4 2020.
Credit: Josh Young, SubuTrade (via X.com)
To put that into perspective, here's the all time range of XLE -
This, likely coupled with the Biden victory essentially marked capitulation in the sector which led to well over 3x returns in the following 12 months.
Additionally, dealer positioning appears to be supportive into most, if not all of Q1. For January, dealers are short puts at $80 on XLE while the $88 and $90 strikes are maintaining the largest net gamma. With price closing at $84.56 as of 12/27 and shares dipping as low as $82.75 this past week, we are much closer to dealer support than we are to resistance and we have quite a bit of room to make up on the upside should the $88-$90 area be the closing print on Jan 17th.
Going out to March opex, there is also an enormous amount of put support at $82 which suggests sellers will have an extremely hard time keeping us below that strike the closer we get to expiry.
I chose to look at March, not Feb because of the overwhelmingly large amount of open interest (OI) it has which is 2nd only to Jan. Also, notice how 12/27 and 12/31 are somewhat call heavy - this suggests we may be weak into end of year but as soon as the new year rolls, dealers will unclench that negative gamma and allow free movement to the upside.
Credit - Unusualwhales.com
Finally, one last reason as to why we know a large move is coming sooner rather than later -
The Technical range is ready to expand
The subgraph on the charts below represents Bollinger band width. When the blue line is at the high end, it means the current expansion move is getting long in the tooth and price is likely to return to a tighter range. When at the lows, it means that the range is getting tight and volatility is at its lowest. The longer it stays near the lows, the closer we are to seeing energy released (no pun intended).
Of course, this doesn't always tell us which way price will expand - it could expand to the downside as other instances in the past have shown but based on other factors included above it appears that the expansion may be to the upside.
In conclusion, it has been elusive but the beginning of every bull market is filled with doubt, despair, and lack of confidence. I believe energy could be ripe for a massive trend leg to new all time highs in 2025. What also makes this trade attractive to me is that if this thesis ends up being incorrect and energy does not break out, the downside appears to be quite limited here based on the data above, namely dealer positioning into Q1. Of course any macro trigger or black swan event could destroy this idea but that case could be made for any long side analysis.
Disclosure: Currently long XOM, XLE, OIH.
For access to premium trading content including swing trade alerts & live day trading room visit - https://www.carnivoretrades.com/
Youtube - @carnivoretrades
X - @aaronbasile
Instagram - @carnivoretrades
Substack - @carnivoreaaron