Amid all the noise in the market these days – tariffs, interest rates and pot stocks readily come to mind – is the fact that oil and gas explorers are having an excellent year. In fact, the SPDR Oil & Gas Explorer and Production ETF (XOP) is running neck-and-neck with the NASDAQ Composite (COMP) for gains in 2018. And XOP has gained nearly twice what the S&P 500 has managed and has more than doubled the Dow’s performance.
Now, there’s no doubt that oil-related stocks have been boosted by the surge in oil prices. Brent crude is trading at three-year highs above $80 per barrel. OPEC is threatening to curtail supply and the U.S. wants help in keeping Iranian oil off the market, further reducing supply.
There’s also no doubt that higher oil means shelling out more at the gas pump. In fact, the U.S. national average is nearly 12% higher than it was a year ago, according to AAA.
But I’m not here to talk about money coming out of your pocket. I’m here because my Best in Breed (BIB) model has identified a couple of XOP components that will put money into your pocket. As I’ve said in previous articles, finding the hot sectors is easy. A quick Google search will do the trick. The BIB takes the next step by identifying the best of the best - the stocks that not only have been hot but that should continue to beat the market.
We’ll start with the better known of the two – explorer and producer Hess Corp. (NYSE: HES). HES has been a beast in 2018, gaining nearly 50%. And, as the chart below shows, it’s been steadily walloping the XOP throughout the year.
What’s more, the stock set a three-year high earlier this week. But while 2018 has been stellar, HES is a long way from its all-time high of $137, reached in 2008. Looking at the longer term, this year’s strength has turned the 20-month moving average higher for the first time since late 2014. The last time the 20-month turned higher was in early 2013, as the stock was in the midst of a two-year rally that boosted the share price by more than 160%.
Regular readers of my columns know that one of my Trading Commandments is “Short sellers are usually a bull’s best friend.” That certainly holds true for HES, which has been boosted by a massive unwinding of short positions since April. In fact, the amount of short interest has been reduced by more than half as short sellers have been forced to cover their positions by buying stock. But the short squeeze isn’t over, as HES’s short-interest ratio is still at a healthy 7.0. That tells me there’s more than enough short interest to continue the squeeze that will power HES higher.
With plenty of short interest available, room to run on the chart and ample pressure on oil prices, I’m looking at the 2015 high at 79 as my near-term target for HES.
My second XOP outperformer is Bermuda-based Kosmos Energy Ltd. (NYSE: KOS). KOS is an explorer and producer with assets primarily in Africa and South America. Like HES, KOS has easily outdistanced the XOP, returning 36% so far this year. More impressively, the stock hit a three-year high on Tuesday that was nearly 90% above its 2018 low in February.
Like HES, a longer-term view tells a bullish story. KOS has been rallying since hitting an all-time low in early 2016. The rally has seen the shares triple in price and has pulled the 20-month moving average into a bullish cross above the 50-month moving average. Over the past year, KOS has been aided by a short squeeze that has sliced the total amount of short interest in half. Yet, like HES, the current short-interest ratio stands at a “squeezable” 8.9, meaning the short covering is far from over.
With strong technicals, no resistance overhead, oil price strength and a short-covering rally that has room to run, I’m targeting a move to 11, which retraces about a third of the stock’s huge decline from late 2009 through 2015. The April 18, 2019 7.5 call is well priced to take advantage of the stock’s expected strength (and is the longest-dated option available for KOS).
Potential short squeezes are a great reason to jump aboard a stock that is technically strong. But when the short covering is in progress, as with HES and KOS, the rally has a much better chance of continuing. Consider these stocks now before the short interest runs out.