Trend: Energy stocks will rebound rapidly when the economy starts recovering.
Jim Kingsdale at Energy Investment Strategies describes the new dynamics of energy prices and the trade-offs of buying now versus waiting for an economic upturn.
Link: Energy Stocks Will Roar Back - But Not Soon | Jim Kingsdale's Energy Investment Strategies.
...oil prices are now leveraged to GDP. This is a new phenomenon. Prior to peak oil, it was not the case so much. There was a correlation of oil and the economy but it was not supercharged (except during the time of radical OPEC-induced shortages).
Meanwhile oil equities are leveraged to oil prices. Therefore oil equities are more than supercharged to the direction of GDP. So if GDP is now only in the early stages of falling then this is not the time to own oil stocks. That’s not to say we might not get a bounce in oil stocks from an oversold condition from time to time, as happened last week. It’s also not to say that global GDP has to be actually recovering before energy stocks will rise; we know stocks will anticipate global growth once there is some sniff of recovery or even bottoming in the air. But I think we should at the least want to see some slowdown in the rate of economic decline before we buy energy stocks.
That’s not to say that a slowdown in the rate of GDP decline must actually be published in the newspaper before we buy oil stocks. It might be too late to buy the oil stocks at that point. No, the first evidence that the rate of economic decline has slowed and therefore the turn-around has begun to begin will probably come from a sustained rally in stocks, which will include oil stocks. I don’t mean just a rally; I mean a sustained rally, one with pullbacks, higher highs and higher lows.
Of course if we wait for such a rally we will certainly not have been buying at the bottom. Buying or owning oil stocks at the bottom of this bear market is an enticing objective. It holds the promise of our recovering a lot of our lost asset values rather quickly. Many investors are acutely aware that there is so much cash on the sidelines and so much desire to participate in a rally in order to make up some of the losses everyone has suffered that when “the market” sees daylight ahead it will stage an enormous rally. A lot of people want to be at that party.
But the cost of buying now or owning now will be steep if the bottom of the business cycle is two or three or four years off. A great deal of additional asset value destruction could take place over two, three or four more years of declining GDP. So if one’s objective is to buy at the bottom, or at least to own at the bottom, one best hope that the bottom is not too far off. And that in fact is what many people are doing now - owning energy stocks in the hope of a quick upturn in GDP.
So the choice for the oil stock investor is whether to own them now, thus risking further portfolio value declines, or stand aside for now thus avoiding the risk of more portfolio declines but taking an opportunity risk that you will miss out on the early part of what could be a huge rally in stock prices. It is an individual choice. Whatever your choice, make it with the knowledge that in owning oil-related stocks you are super-leveraging yourself to economic conditions. If we are near a bottom in terms of GDP reduction, you could do very, very well. But if we are years away from it, the additional decline in your portfolio from here could be serious. That’s because the price of oil and the value of oil related equities are so closely tied to GDP growth or decline.
A break-out about $60/bbl for oil or $37 on the chart could signal a new upswing. If that happens, oil will become more profitable making the energy sector more attractive....
Posted by: commodities | April 24, 2009 at 05:01 AM