Energy Still Spells Opportunity-Kiplinger

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Energy Still Spells Opportunity

Steven Goldberg

Even though the short term looks bumpy, you can still make money in energy stocks. Avoid investing directly in the commodities, though, whether through futures or funds.



Just like technology-stock investors six years ago, investors in energy stocks are discovering that what goes up can also go down. This decline is different than the tech-stock massacre, though: Most investors should ride it out.

You should hold on, that is, so long as you didn't overdo it in the first place. An energy/commodity fund ought not represent more than 5% or so of your stock investments. After all, your diversified stock funds already probably hold a generous slug of energy. The SP 500 is currently 10% energy -- nearly double what it was four years ago.

I'm even more suspicious than I have been of straight-up commodity funds, such as Pimco Commodity Real Return. I like to invest in companies, not barrels of oil and metal ingots.

The price of oil has plunged to around $60 a barrel after cresting at $78 in mid July. Other commodities have followed suit. Ditto for stocks of energy and other commodity companies. "We've probably seen the highs in commodity prices for this cycle," says Charles Ober, manager of T. Rowe Price New Era (symbol PRNEX), which specializes in these stocks.

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I have a lot of respect for Ober. Along with Chris Davis, the savvy manager of Selected American Shares, Ober was one of the first fund managers to turn bullish on oil. It's hard now to recall how unconventional such a stance was in early 2004 -- when oil and gas had been in a quarter-century bear market. Oil breached $40 a barrel that year -- a price that seems cheap now.

Nevertheless, you can still make money in oil and other commodities -- even as their prices flatten or decline. That is, you can make money owning the stocks. Energy stocks are priced as though oil will drop to $45 a barrel, Ober says. But he thinks the price is likely to settle around $50 over the next three or four years and that it will take its sweet time falling that far.

No question: Commodity stocks will fall in tandem with the commodities. But that's short-term thinking. Over the mid- and long-term, the prices of these stocks should move primarily with their earnings -- not with the commodity prices. And nothing has changed the supply-demand equation: While signs of sluggishness are abundant, the global economy is still in a long-term growth pattern -- and the world requires more oil and other commodities.

It's a different story for funds that invest in commodity futures and other derivatives: If oil declines further, your investment will fall with it dollar for dollar. And it will stay down unless the commodity price heads back up.

The plunge in commodity prices was totally predictable. The catch, of course, was that no one knew when it would occur -- nor how high prices would climb first. What happened? Speculators finally panicked and pushed the sell button (not before two big hedge funds got clocked), the hurricane season was unusually mild and inventories have been building.

With the summer driving season behind us, Ober sees prices falling below $60, but not too far below that for now. Saudi Arabia will slash production if the price falls much lower than $60, he says. Ober's caveat: There are still big geopolitical risks to supply. The one that worries him most is Iraq, which still produces oil that the global economy needs.

Ober likes energy services, and his favorite is giant Schlumberger (SLB), which has good relations with almost all the big oil-and-gas producing nations, regardless of their politics. He's also bullish on French oil major Total (TOT). "It's an Exxon-type company in that it's financially disciplined, yet it sells at a much cheaper price," he says.

Outside of oil, Ober's favorite long-term holding is BHP Billiton (BHP), the Australian mining conglomerate.

Personally, I'm more comfortable with Ober's fund. Even after tumbling 9% in the past month, it's still up 1% this year through September 25. Over the past five years it has returned an annualized 20%. True energy bulls should consider riskier RS Global Natural Resources (RSNRX), which is up 1% for the year and down 11% over the past month but has returned an annualized 28% over the past five years.

Steven Goldberg is a freelance writer and former senior associate editor of Kiplinger's Personal Finance magazine.




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