Energy stocks are the talk of the town again after losing over 14% last week. After gaining over 70% in 2022, the Energy Select Sector SPDR Fund (NYSE: XLE) was close to the last safe spot for investors. XLE stock is still up 30% YTD, and many signs signal the run is not over yet.

At the same time, with talks of a recession picking up, is it time to give up on energy? Many energy stocks are trading back to prices before the war in Ukraine broke out. But oil futures are still up over 50% from last year. And the gas situation is even more of a challenge.

Gas futures are up over 100% from last year, and prices at the pump are right below all-time highs. Meanwhile, the Fed and Biden administration are using all the tools available to bring some relief. The Fed just raised interest rates by the largest amount since 1994.

Not only that, but President Biden tapped the strategic oil reserve, is working with OPEC to increase supply, and calling out oil companies to do their part.

Will it make a difference? XLE stock looks ripe for a bounce. Here’s what you should know before buying.

No. 4 Commodities Often Run in Multi-Year Cycles

When the commodity market rallies, it can last years before turning over. In fact, these extended rallies are called “Super Cycles.”

For example, in the 1930s, commodities rallied as the U.S. prepared for WW2. Then again, in the ’90s, as industrialization swept across the nation. And the most recent, peaking around 2012-14 as emerging markets developed.

Researchers have several reasons to explain why these cycles happen.

1. New projects take years to complete.
2. Supply and demand drive commodity prices.
3. A specific event usually triggers rallies.

The most important thing to know when considering buying XLE stock is knowing that commodity prices, such as gas and oil, are driven by supply and demand. With this in mind, energy prices are rapidly rising due to higher demand and a limited supply.

For one thing, over 100 oil and gas companies went out of business during the pandemic. As travel halted, energy demand fell off a cliff. Meanwhile, energy companies had no choice but to go bankrupt.

Fast forward a year, the economy reopens again, and demand shoots through the roof. But, with less capacity, companies are struggling to keep up.

No. 3 Energy Supply Is Still a Concern

After underinvesting for many years leading up to the pandemic, the industry was due for a shakeup. As leaders promised a new “green” future, investors poured money into renewable energy investments. As a result, the oil industry cut back on projects and was forced to abandon others.

So, supply was limited to begin with. And then Russia invading Ukraine was the final straw. NATO leaders decided to ban or restrict oil coming from Russia.

The oil ban caused a ripple effect across energy markets as oil prices briefly soared over $120 a barrel. Meanwhile, the gas situation is even more challenging as refining capacity in the U.S. nears maximum. To explain, refiners turn oil into gas and other by-products. Many companies that went out of business were either E&P (drilling) or refiners.

In fact, the latest data from the Energy Information Administration (EIA) shows refinery capacity is at 94%, the highest since the pandemic.

With this in mind, there’s only so much capacity in the U.S. to make gas. In other words, supply is limited. So, by raising interest rates, the Fed is going after demand. To slow demand, the Fed is makes borrowing more expensive.

For example, higher interest rates may mean fewer vacations or travel. As a result, less gas is being used in the economy, whether by car or plane.

No. 2 XLE Stock Was Due for a Pullback

This year, energy has been the only strong sector in a very weak market. To illustrate, XLE stock gained over 68%, hitting a 52-week high of $93.3 per share earlier this month.

But with talks of a recession and a bear market looming, XLE shares gave in like the rest of the market. Eventually, every sector or market gets sold during a bear market. And last week, the time came for energy stocks.

At the same time, XLE shares reached overbought levels according to the Relative Strength Index (RSI). Though XLE stock hit overbought on the daily, weekly, and monthly charts, quarterly sits below 60.

Meanwhile, many energy stocks are trading back to prices before the war in Ukraine started. For instance, EOG Resources (NYSE: EOG), one of the largest natural gas companies, sits at $111, the same price as when the war started.

Although this may be true, the uptrend in most oil and gas stocks is still intact. For one thing, many energy stocks are trading above their 200D SMA, a sign of momentum.

Lastly and most importantly, the stocks fell to critical levels of support. Not only is XLE stock sitting on this year’s volume-weighted average price (VWAP), but it’s also right around a historic level of resistance.

XLE stock was due for a pullback, but will it continue to crack? Or was it just a shakeout?

No. 1 Hedge Funds Buying with Record Cash Flow

Energy has been one of the stock market’s only places to earn a return this year. Then again, oil companies are making record cash flows with high energy prices. And as a result, they are splitting the profits with investors through dividends and buybacks.

You may have even heard President Biden saying Exxon Mobile (NYSE: XOM) made “more money than god” this year. For one thing, several tech companies make more than Exxon. But he has a point. In the first quarter, Exxon generated $14.8 billion in free cash flow (FCF).

Besides that, with energy prices hitting a record high, Exxon announces a $30 billion share buyback plan through 2023. On top of this, Exxon is the largest holding in XLE stock. So, what benefits Exxon stock also benefits XLE stock. It’s no wonder investors and hedge funds are interested in the market.

According to information from Hedgefollow.com, the XLE ETF continues to see heavy institutional buying. In fact, buying activity in Q1 was the highest since Q2 2014.

XLE Stock Forecast: Do We See a Bounce in XLE Share Price?

The XLE stock selloff last week came due to a change in investor expectations. At first, investors braced for high inflation and low growth, also known as Stagflation.

But with the Fed raising interest rates, a new concern is developing. What if the Fed raises interest rates too quickly, sparking a recession? If this is the case, demand could fall drastically.

At the same time, until proven otherwise, the story remains the same. Energy is essential for the economy to function. With near-record energy prices, companies are generating massive amounts of free cash flow.

And consumers are still paying for it. According to new research from Yardeni Research, families in the U.S. are paying $5,000 a year on gas, up 78% from last year.

Is this the start of a new multi-year cycle? The big question will come down to how effectively the Fed will bring demand down.

As for XLE stock, I believe the ETF has more gas in the tank this year. With summer demand revving up, I wouldn’t be surprised to see the rally continue. And then, into hurricane season, we could also see a boost. That said, a recession could take the market lower.

In the long run, the direction many nations are heading is clear. To meet their climate goals, many leaders are investing in renewable energy. Although XLE stock holds some clean energy businesses, it mainly invests in oil and gas. If you wish to get ahead of the clean energy movement, check out these top renewable energy stocks for long-term growth.