Stock Chart Pattern – Cairn India (an update)

In my previous post about the stock chart pattern of Cairn India a year back, the overseas promoters were trying to offload the company to the Vedanta group. A lot of water has flown down the Ganges since then, but the Vedanta group has still not been able to complete the Cairn acquisition. 30% owner ONGC raised objections regarding royalty payment, and the deal has been going around through various government departments. Every time it seems that the deal is nearing completion, some one throws a spanner in the works.

Recently, the shareholders voted for the proposal of royalty sharing with ONGC, followed by ONGC agreeing to provide a no-objection certificate subject to a binding legal agreement between the two owners on royalty sharing. Only a few minor procedures and approvals are left for the deal to finally conclude successfully.

A different problem has now cropped up. Several members of the top management at Cairn India, including the CFO, have left the organisation recently. Apparently, professional managers were apprehensive of working with Vedanta's Agarwal. In a specialised business like oil exploration, loss of top management staff may hamper future prospects.

How have the procedural delays regarding the acquisition and exit of top management staff affected the stock's price? The one year bar chart pattern of Cairn India shows that the damage has been substantial: 

The stock price had started correcting after touching a high of 368 in Aug '10. The correction continued till the stock price fell sharply to a low of 285 in Nov '10, well below the rising 200 day EMA. The recovery was equally sharp, but the price momentum slowed down and the stock price reached a lower top of 347 in Jan '11. Another bout of correction dropped the stock below its 200 day EMA once more, but to a higher bottom of 306 in Feb '11.

This time, the stock sailed past its previous top to a new high of 372 in Apr '11, but formed a 'diamond' reversal pattern that marked the end of the bull market. The 'diamond' can be thought of as a head-and-shoulders pattern with a bent neck line that has measuring implications. From the break out point - usually downwards - the stock price is expected to drop at least the same amount as the height of the 'diamond'. In this case, about 40 points.

Note that after breaking down below the 'diamond', the stock consolidated for more than a month between support from the 200 day EMA and resistance from a horizontal line drawn through the right apex of the 'diamond'. Eventually, the stock broke below the 200 day EMA on Jun 17 '11, and quickly reached its downside target over the next two trading sessions.

A recovery followed, and the stock managed to climb above the 200 day EMA on intra-day basis, only to face resistance from the horizontal line through the apex of the 'diamond'. Such 'coincidences' make technical analysis interesting. The bears decided enough was enough. Heavy selling dropped the stock deep inside a bear market, where it touched a low of 250 in Aug '11 - a 32.8% correction from the peak of 372.

A rally took the stock past its falling 20 day and 50 day EMAs, but fell short of the falling 200 day EMA. The stock is trading below all three EMAs and is in a bear market. The technical indicators are looking quite bearish. The MACD has crossed below its signal line into negative territory. The ROC has fallen steeply below its 10 day MA into negative territory. The RSI has dipped below the 50% level after reaching its overbought zone. The slow stochastic has descended from its overbought zone, and is below its 50% level.

Bottomline? The stock chart pattern of Cairn India is suffering due to technical and fundamental headwinds. If you are holding the stock, use any rise to exit. New entrants should await the acquisition deal to go through, and the stock to form a bottom. The Vedanta group has acquired a few companies in the metals and mining sector, but have no experience in the oil exploration business. Keep that in mind if you are contemplating an investment.

Why did crude oil price fall so suddenly?

Before we try to analyse the reasons for the sudden sharp fall in the price of crude oil – let us pause for a moment to heave a sigh of relief. Rising oil price worsens India’s huge fiscal deficit, curtails expenditure in developmental activities, and dampens growth. Another round of petrol – and possibly diesel – price hike is imminent.

That would further stoke the already raging fire of inflation – notwithstanding RBI’s aggressive interest rate increase. After nine straight days of correction in the Indian stock market – during which the Sensex fell nearly 7.5% – the fall in oil price is as welcome as the first drops of rain after a long, hot summer.

Why did oil price fall so suddenly? The first and most obvious reason is technical. A look at the 3 months bar chart pattern of NYMEX Light Crude oil below shows the strong spurt in price from 83 in mid-Feb ‘11 to 114 in end-Apr ‘11 – a 37% gain in less than 3 months. Most of the gains was speculative, caused by the unrest in the Middle East which didn’t really hamper supplies much. Sudden unloading by speculators typically cause such sharp corrections.

(Powered by Dukascopy)

What triggered the sudden unloading? The entire commodities space got spooked by the disappointing unemployment data from USA. Not just crude oil, but investor favourites like gold and silver also nose-dived. There are reports that consumers in USA are opting for more fuel-efficient cars in the wake of rising gasoline prices and painfully slow growth of the economy. That will reduce demand for oil.

There is an interesting political spin on the fall in crude oil price. Apparently, Saudi Arabia played a behind-the-scenes role in persuading Pakistan to hand over Osama bin Laden to the Americans. In the process, they killed two birds with one stone. Bin Laden’s elimination expectedly came as a feather in the cap for US President Obama, and will boost his chances of getting re-elected. Why not keep the most powerful man on earth in good humour?

Saudis already contribute large sums of money to Pakistan. They may have promised more, as well as offering them a greater role in peace-keeping in the Middle East – thereby enhancing Pakistan’s prestige and credibility. Both have taken a severe dent after the covert US operation to eliminate bin Laden. Pakistan had previously helped Middle Eastern countries in quelling uprisings during General Zia’s regime. A Middle East sans strife means a fall in oil price to more reasonable levels.

However, the present supply is unable to keep pace with growing demand for crude oil from populous countries like China and India. So, there is no reason to expect a drastic fall in oil price. Experts are projecting oil price to stabilise at 90.

RBI raises interest rates – markets crash; what should investors do?

Regular readers of this blog should not have been too surprised by today’s selling, which followed the RBI announcement raising the repo and reverse repo rates by 50 bps (0.5%) each. In last Saturday’s analysis of the Nifty chart, I had mentioned the possibility:

‘The markets have already discounted a likely 25 bps interest rate hike by the RBI next week. If the actual hike is 50 bps, there can be more selling.’

The RBI governor had adopted a graduated raising of interest rates so far, taking baby steps of 25 bps on the past few occasions. Market players had expected a similar hike this time around, but were taken aback by the aggressive stance of the RBI. So, they decided to head towards the ‘Exit’ doors.

What signal is the RBI trying to convey? Inflation has now become a bigger concern than growth. It needs to be contained, even if growth slows down in the near term. Is that the right thing to do? What happens over the next few months will provide the answer to that question. Interest rate hikes take some time to percolate through the financial system.

The fact is, the earlier rate hikes of 25 bps at a time - in an effort to balance inflation and growth - has not really worked. Inflation continues to remain high, though it has reduced from double digits to single digit. The unrest in the Middle East caused a spike in oil prices that made the inflation situation even worse.

Thanks to the elections in a few states, petrol prices have not been raised. But they surely will be, once elections are over. Diesel, kerosene and cooking gas subsidies are huge burdens being borne by the oil marketing companies. At some point, diesel prices will need to be de-controlled. That will further stoke inflation.

The RBI governor decided to bite the bullet and tackle inflation with a heavier hand now. Higher interest rates will hinder the already slowing credit off-take and capex plans of India Inc. GDP growth in FY12 is expected in the 7.5% – 8% range. Not bad, but lower than earlier forecasts. Profit margins of India Inc. will reduce. That is why the sell-off happened today.

What should small investors do? Some times the best thing to do is to do nothing (and enjoy the extra 0.5% interest in your savings bank account that RBI doled out). Wait for the dust to settle, and the selling to subside. Then pick up some of the better stocks that may have been beaten up badly, and whose valuations start to look attractive.

Related Post

The Interest Rate hike was expected – why did the market fall?

The implication of high oil price for investors – a guest post

With oil prices ruling above $100 per barrel, India’s trade deficit is widening and inflation remains a major concern. In this month’s guest post, Nishit looks at the implication of high oil prices for investors, and suggests how we can benefit from this adversity.

------------------------------------------------------------------------------------------------------------

From a low of about $33, Crude Oil has now spiralled up to a high of almost $110 a barrel. Crude Oil is the lubricant which runs the world, so let us investigate why the rise in price and what are its implications for India.

Most of the crude oil deposits lie in the Middle East. Middle East has been racked by turmoil and unrest. Supply of oil has been threatened in Libya and other parts like Saudi Arabia. The price rise has been mainly on the back of supply concerns.

India imports 70% of its oil, and if the price rises it implies that it would need to spend more dollars to buy the fuel. A country earns dollars by exports, inward remittances by Indians settled abroad and also foreign investments into India.

We spend the dollars on imports. The difference between exports and imports is known as Current Account Deficit. As we import more than we export, we are always in trade deficit.

If Oil is pricey, the deficit widens, and India’s credit worthiness declines making it less attractive for foreign investors. Petrol price rise gets passed on to the consumer, thereby leaving him with less income to spend.

Subsidy on Diesel of almost Rs 18 to a litre weakens government finances leaving it with less money to spend on infrastructure and developmental activities.

In 2008, crude oil price rose and peaked at around $145 per barrel. All the time, as oil price was rising the equity markets did not react too much to the price rise. A month after the prices peaked, the markets tanked. This was aided also by the Lehman Brothers meltdown.

Now how do we play this as small investors?

We have oil producers like ONGC and Cairn. Cairn is a major beneficiary but now caught up in legal tangle over its acquisition by Vedanta, and ONGC has to bear the subsidy burden.

The legal tangle has no effect on its daily operations and hence I would still prefer Cairn to ONGC. Portfolio allocation could be these two companies and Gold. Average gold price per ounce is 15 times a barrel of oil. This implies fair price for Gold now is $1650 per ounce.

This also means avoid the Auto sector, Banks and anything which is linked to rising Interest Rates. Rates will keep rising as government battles inflation and also seeks to raise more money to pay for oil.

Don’t like the petrochemicals sector? Long Gold and short Banks could be an interesting option.

------------------------------------------------------------------------------------------------------------

(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

Related Post

Cairn India: an oil story worth betting on – a guest post

Why Japan’s calamity can hurt the global economy and stock markets

There is an English proverb: Misfortune never comes alone. In Japan’s case, misfortune seems to be coming in droves. Before the stoic and resilient people from the island country could recover from the horrendous calamity of the massive earthquake and devastating tsunami, the explosions and radiation leaks from the ageing Fukushima nuclear power plant has sent shock waves through the entire global economy.

Oil prices dipped on the assumption that demand from Japan will diminish as the economic growth may stall while the nation reconstructs the severe damage to life and property. Japan is the third largest oil consumer in the world, and there may be a drop in demand in the near term.

But global demand for oil may increase. Many countries, including the USA, depend on oil for their energy requirements – unlike India where coal-fired power generation is the norm. The US-India civilian nuclear treaty was supposed to be a win-win agreement for both. New nuclear power plants built with US technology was supposed to alleviate India’s perennial power shortage, and boost the demand for US-made equipment and consultancy services. The crisis in Japan’s nuclear power plant, built with equipment and technology from the US giant General Electric, will now put nuclear power as an alternative energy source on the back burner.

Japan also happens to be a large market for luxury goods, with more than 10% of world sales. Any further slowdown of an already slowing Japanese economy will seriously affect the businesses of luxury goods makers the world over. Many of these luxury goods – whether Gucci bags or parts for BMW cars – are actually manufactured in Asian countries.

With the Japanese Nikkei index taking a beating, investors are likely to pull out of Japanese funds that invest in global stock markets to cover their losses. As per a CNBC report, more than US $7 Billion has been invested by Japanese funds in Indian markets – and that is less than 20% of their total investments in emerging markets as a whole. The Sensex dropped 18% when FIIs recently pulled out US $2 Billion. Any Japanese withdrawal can cause a much bigger correction. Already, European indices have felt the heat.

Many Indian companies have built up their Japanese bases over a long period of time. Infosys and TCS are among them. There is talk of repatriation of Indian employees. It remains to be seen what effect that may have on the bottom lines of Indian companies.

Unlike the rise in oil prices, which every one expects to moderate in the near term as the unrest in North Africa and the Middle East gets quelled with firm hands, the crisis in Japan isn’t going to end soon. A melt-down in a nuclear reactor in a populated area can have serious long-term repercussions. Operations of many global companies will be disrupted because of damaged roads and ports, and shutdown of manufacturing facilities.

Indian investors need not sell in a panic. Corrections due to ‘black swan’ events, like the one in Japan, provide buying opportunities. Be patient and stay prepared for a deeper correction.

The state of the stock market – a broker’s views

I cornered my erudite stock broker friend just after he had finished his morning round of golf, and asked him about the current state of the stock market. Here, in no particular order, is the gist of his uncensored views during a freewheeling discussion:-

1. The Sensex is very likely to test its recent low of 17300. It may even go down to 16000, but the probability is low.

2. The market is likely to trade in a range for another 3 months, or even longer. With high oil prices further messing up India’s fiscal deficit, markets won’t be able to move much higher.

3. The second half of the year should be ‘technically’ better. That is when the ‘big players’ have decided to sit down together with the Udayan Mukherjees of the business channels to decide (and announce) where they are going to push up the stock market.

4. Oil prices won’t come down any time soon. The turmoil in the Middle East and North Africa will be fomented by the USA for two main reasons. The first is their insatiable desire to corner oil resources, which was the main reason for their invasion of Iraq. Every one knew that there were no ‘weapons of mass destruction’ in Saddam Hussein’s armoury.

The second reason is the dismal state of the US economy. All the dollar printing hasn’t improved anything. The US economy thrives after wars. A Republican president would have used the Tunisia and Egypt uprisings as excuses to send troops. The Democrat president is pussy-footing around. But he will soon have no choice but to start a war by sending in the US marines. There is already talk of enforcing a no-fly zone in Libya.

5. The talk of ‘valuation difference’ between developed and emerging markets being the reason for the recent correction is all hogwash. Valuation differences were there a year back, when FIIs were pouring money into emerging markets.

6. The export lobby has been moaning and groaning about the rupee appreciation against the dollar hurting the country’s exports. There is not a peep from the import lobby because none exists. The government is the biggest importer. They should ignore the exporters and let the rupee appreciate against the dollar. That is the only way to cushion the rising cost of oil imports. Imports far exceed exports anyway.

7. There is no greed and fear in the Indian stock market. There is only more greed and less greed. Nothing else explains the paltry cash volumes compared to the huge F&O volumes of trade every day.

8. Small individual investors in the more evolved and sophisticated US market invest mainly through mutual funds. In India, any one who has Rs 5000 to spare wants to invest in equity shares. Since he doesn’t have enough money to buy even 10 TISCO shares, he goes out and buys 15000 shares of Cals Refineries. How smart is that?!

Part of the blame lies with us brokers, who want investors to regularly buy and sell stocks, because our livelihoods depend on that. But, small investors will be far better off investing regularly in an index fund or a balanced fund.

Gold Chart Pattern: another buying opportunity?

Last month, gold’s 2 years price chart was struggling to move above the 30 day SMA after recovering from a drop to 1315 from its earlier peak of 1421. I had suggested buying below 1340, and accumulating on a convincing move above 1356. After consolidating a bit near 1356, gold’s price shot up close to its previous high of 1421, and after a brief pause rose to a new all-time high of 1437.

Profit booking seems to be the reason why the price has slipped to 1411, just below the rising 14 day SMA. Can it fall some more? Yes, it can. It has already dropped below the triple top at 1421. The next support level is at 1400, from where an upward bounce can be expected.

Is this correction another buying opportunity? Yes, it is. Note that the 200 day SMA continues to rise, and gold’s price is trading much above the long-term moving average. That is the sign of a bull market, and the strategy should be to ‘buy the dips’. Note that the chart pattern is close to two previous peaks. Accumulating in small quantities would be a more prudent approach, rather than buying in bulk.

How long will this bull market in gold continue? Who knows, and why should investors be bothered? There is still a lot of uncertainty all around. Emerging markets are facing inflation pressures, which could lead to a slow down in their economies. The recoveries in the US and Europe have been less than stellar so far. The unrest in North Africa and the Middle East is pushing oil prices higher, which will not at all be conducive to faster economic growth.

Gold seems to be the safest haven of all. Stay invested with a suitable trailing stop-loss, may be at the level of the rising 200 day SMA. That is as close to a ‘sure thing’ as you can get in investing these days.

How much longer will the Sensex trade within a range?

That may be the question on the mind of many investors, as the Sensex has been trading between 17300 and 18700 for the past 5 weeks. The short answer is: I have no idea. It could be six weeks or six months. Buyers and sellers seem evenly matched. The post-budget rally appears to have come to an end.

What could be the triggers for the Sensex to move up?

1. The RBI may not increase interest rates on Mar 17. Since inflation remains a concern, another 25 basis points rate hike is being expected by market players. Ms K Morparia of JP Morgan said in a recent TV interview that she won’t be surprised by three more rate hikes of 25 basis points each. Not increasing the interest rate will be taken as a positive by the market.

2. Q4 results will hit the market in another 5 weeks or so. With higher commodity prices and higher interest rates, profitability of India Inc. is widely expected to take a hit. If results are flat, even if not better on a QoQ basis, markets may interpret that as a positive.

3. India is still dependent on good monsoons. Agricultural production gets a boost. That helps the rural economy to grow, and has a cascading effect on the economy as a whole. Signs of a good monsoon may shake the market out of its current gloomy sentiment.

What could be the triggers for the Sensex to go down?

1. Despite several rounds of interest rate hikes by the RBI, inflation continues be in double digits. Government spokespersons have run out of excuses. More rate hikes could bring the growth momentum to a screeching halt.

2. The unrest in North Africa and the Middle East has sent oil prices shooting up into three figures. Economic growth and high oil prices are a disastrous combination for stock markets. If oil prices remain high, India’s fiscal deficit and inflation may spin beyond control. As it is, artificially depressed kerosene and diesel prices is causing havoc to the finances of the oil companies. The real inflation rate is much higher than the published figure.

3. The FIIs have pulled out about $2 Billion from the Indian markets in 2011. This amount is less than 10% of what they invested in 2010. Still the Sensex lost 18% from its Nov ‘10 peak. The relative valuations of the US and Europe markets are cheaper. If the FIIs continue with their selling and pull out another $2 Billion, the Sensex could test its May ‘10 low of 16000.

Looks like the sideways consolidation in the Sensex may continue for a while longer. As I have mentioned several times before, investors should not get too bogged down by Sensex movements. When the market is unexciting and boring, it may be a good time to take a vacation and catch up on your reading. If you have already read books by Graham, Lynch, Fisher, Pring – read them again. You will understand many things that you missed when you read those authors for the first time.

Why Indian investors should look at Emerging Market ETF charts

Indian investors have been worried about why the FIIs are pulling out of emerging markets and redeploying in developed markets. Some say that the relative valuation difference between emerging markets and developed markets is the real cause. Others are of the opinion that this is not a flight of capital but routine profit booking. There is another school of thought: the turmoil in North Africa and the Middle East has pushed up oil prices and made emerging markets riskier.

There is no doubt that FII selling in emerging markets has affected the Indian stock market indices. The series of scams – be it the inflated costs for the Commonwealth Games, or the telecom 2G spectrum allocation, or the various scams involving real estate development – seems to have shaken the confidence of the FIIs. The rising inflation rate, leading to a steady rise in interest rates, has increased the cost of doing business.

When and how will this situation get turned around? Politicians, government officials and the real estate mafia are not going to turn into honest and law abiding citizens overnight. Nor can inflation be curtailed by pressing a button. Who knows where the Middle East turmoil will be heading? In other words, the uncertainty overhang can not be wished away. And stock markets hate uncertainty.

Is the current fall in the Sensex and Nifty 50 a good buying opportunity? Will prices become even more attractive if one waits? How can an ordinary small investor decide what to do in uncertain circumstances? When fundamental analysis can’t provide clear answers, one has to look elsewhere.

Given below are the one year closing charts (in blue) of two Emerging Market ETFs traded in the US market – the iShares MSCI Emerging Index ETF (EEM) and the Vanguard MSCI Emerging Markets ETF (VWO). Superimposed on the two charts are the BSE Sensex chart (in green) and the S&P 500 chart (in red):

Since both the EEM and VWO ETFs track the MSCI index, their chart patterns are similar. The BSE Sensex was the clear outperformer during the period Jun – Nov ‘10. EEM and VWO ETFs caught up and outperformed the Sensex during Jan – Feb ‘11, even as they corrected down. Percentage profit booking in the Indian indices exceeded the selling in the MSCI emerging markets index.

During Feb ‘11, the S&P 500 has been the outperformer, but the gaps between the S&P 500 and the two emerging market ETFs are reducing. It is interesting to observe that the recent rallies in EEM, VWO and the Sensex have coincided with profit booking in the S&P 500.

Indian investors would do well to track the EEM and VWO ETFs for signs of FII investments returning back to emerging markets. Without FII buying support, the Indian markets are not going to move up any time soon.