Another short-term caution sign for crude oil and energy stocks

Key points:

• Industrial metals closed at a 3-month high, and crude oil closed at a 3-month low
• After similar divergences, crude oil and energy stocks struggled in the near term
• The mixed message led to tepid results for industrial metals and had no impact on the broad market

Industrial metals and crude oil are heading in the opposite direction

For the first time since 2014, industrial metals closed at a 3-month high as crude oil closed at a 3-month low. Should we be worried about the mixed message from commodities that play a vital role in the business cycle engine? 

To identify other historical instances similar to now, I will apply the same range rank methodology used in a recent note, highlighting the divergence between energy stocks and crude oil. So far, that market message has played out precisely as history suggested, with the energy sector falling -8% and crude oil declining -6%. 

I screened out repeats by requiring the industrial metal rank to fall below 45% before a new signal could occur again.

Similar divergences preceded negative returns for crude oil

When industrial metals close at a 3-month high as crude oil registers a 3-month low, something is amiss with oil as the commodity continues to exhibit adverse price action over the following month. The signal shows a loss in 9 out of 11 cases over that period.

Energy stocks are likely to follow crude lower in the short-term

As expected, the adverse price action in crude oil impacts the energy sector in the near term. However, energy stocks tend to bounce back nicely over extended periods, especially three months later. The 2014 instance is the only signal that marked a significant top.

Similar divergences preceded mixed results for the S&P GSCI Industrial Metals Index

After a divergence signal, industrial metals exhibit tepid results over the next few months. And the long-term results are mixed, with a negative return in the six-month window but robust results a year later. 

The broad market doesn't care about a divergence between industrial metals and crude oil

The mixed message from industrial metals and crude oil did not impact the broad market. Returns, win rates, and z-scores were solid across all time frames, especially the long-duration ones. 

What the research tells us...

Supply and demand ultimately drive the long-term trend for crude oil and other commodities. In the near term, fundamental drivers can take a backseat to technical factors like positioning. Something is amiss with oil as it has diverged from industrial metals over the last three months. Regardless of the reason, the near-term outlook for crude oil and energy stocks appears troubling. However, if we lengthen our time horizon, we should buy the dip in energy stocks. From a broad market perspective, the divergence between the two commodities has not been a harbinger of doom and gloom as the S&P 500 enjoyed health gains.