The stock of the oil and gas exploration and production company Santos (ASX: STO) has been experiencing a positive year so far. However it is more than likely that a correction will drive the price lower in the coming weeks.
Let’s see why. First, we have plotted on the chart both the stock price action and the Natural Gas futures contract (in green). From June 2007 to late 2008, the two securities have been positively correlated: STO was rising in parallel with the price of Natural Gas, and they were also both correcting with pretty much the same timing and with the same duration.
Since December last year, there is an impressive chartist discrepancy: the stock and the commodity are now totally negatively correlated. It means that from December 10 to date, STO has jumped by 31% from $13 to $17 (with a recent high at $17.96), while price of the Natural Gas contract fell within the same period by 34.5%.
This is typically a kind of divergence, or distortion, that big market players like hedge funds chase. This spread between the two securities appears statistically unlikely. A mean reversion way of trading this would be to sell the stock and to buy the commodity, betting on the spread tightening and a return to more statistically “normal” spread (or ratio).
But this is not the reason why Santos will correct. The main explanation is that the current price action is prevented to move higher by a double resistance.
First, there is an oblique resistance line that goes through the historical high price posted last June (point A on the chart) and the two lower highs posted in late September 2008 (point B) and more recently in late March (point C). This current resistance level, around $17.5, also corresponds to the 61.8% Fibonacci retracement ratio of the decline occurred between the high of June 2008 and the low of October 2008 (point D).
Several indicators show that the bullish momentum is weakening. Therefore a trend reversal is expected. The technical momentum indicator and the MACD have already peaked and curved downward. So did the OBV (On-Balance volume), that tracks the “smart” money flows. Typically OBV changes precede price changes.
In this scenario, a retracement toward previous Fibonacci levels is expected. A target possible is the area between $14.5 and $15, which would correspond to half of the bullish trend occurred between points D and C.