Although the energy sector underwent a sharp correction when the world locked down to control the spread of the novel coronavirus, it has recovered nicely since then thanks to increasing demand for oil. Now, the energy sector is entering its strong seasonal period, which could give it further runway to continue to perform well over the next few months.
Canada’s energy sector had a bumpy ride in 2020. It underperformed when the COVID-19 pandemic was unfolding in February and March, then rallied sharply from late March to early June before declining into late October and then rallying once again through the end of the year and into 2021. Investors changed their outlook for the energy sector depending on the changing expectations on the demand for oil because of COVID-19 and the supply reaction from oil producers, including OPEC+.
The pandemic has disrupted normal demand patterns for oil as countries around the globe have oscillated between different levels of lockdown. As such, it’s difficult to look forward with any confidence in the near future and predict how fast society will increase its demand for oil as herd immunity through immunization moves closer.
There are many models trying to predict consumer behaviour around the pandemic, but with so many variables involved in an unknown and rapidly changing situation, the endeavour is fraught with peril.
While using seasonal trends to assess the potential for an energy sector investment doesn’t ensure success, it can help in determining a potentially favourable time to invest in energy. Specifically, this sector has a strong seasonal period that lasts from Feb. 25 to May 9.
In late winter and early spring, refineries in North America often enact temporary shutdowns for maintenance and switch over their refining capabilities from winter to summer gas. The result tends to be a large demand draw for oil as the driving season, which starts during the long weekends in May on both sides of the U.S.-Canada border, gets underway.
On average, the energy sector tends to perform well from late February to early May as investors enter the sector ahead of the expected increase in demand for oil and gasoline that typically occurs in the driving season.
From 1984 to 2019, the energy sector, as represented by the NYSE ARCA Oil and Gas Index, has produced an average gain of 6.9 per cent in the period from Feb. 25 to May 9. In addition, the sector has been positive 81 per cent of the time.
Commodities and companies that derive their revenue from commodity production and distribution tend to be more volatile than the broad stock market, and the NYSE ARCA Oil and Gas Index is no exception. During the seasonal period from 1984 to 2019, the index has had some large losses and some large gains, but the large gains have far outweighed the losses. In seasonally strong periods, the index has produced a gain of more than 10 per cent nine times, whereas it has produced a loss of that same margin only once.
This year, it’s possible that the seasonal period for the energy sector could coincide with expanding economic growth and more travel. International tourism and business travel may stay suppressed for an extended time, but if the lockdowns were to recede due to diminishing cases of COVID-19, a greater number of car trips would be expected to occur as the economy improves.
As a result, demand for oil and gasoline could move much higher compared with current consumption levels. If this scenario were to develop, it would likely give the energy sector a boost during its seasonally strong period as investors aim to position themselves for higher-than-expected demand for oil and gas.
Although the energy sector has suffered from the economic contraction that occurred early in the pandemic and benefited as expectations for an economic rebound have increased, there is still an opportunity to invest in the energy sector at the right times using a disciplined investment approach. Seasonal investing can provide an investment framework to help in establishing when this sector has performed well, on average, thereby helping to increase the odds of success.
Brooke Thackray is a research analyst at Horizons ETFs (Canada) Inc. He focuses on technical analysis and seasonal investing.