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  • Roger S. Conrad

Those Who Misinterpret the Past Are Doomed Not to Profit

By Elliott H. Gue on Oct. 16, 2015

Market pundits and talking heads who use the 2008-09 collapse in energy prices and related stocks as an analogue for the current downturn fail to distinguish between a demand-driven correction and a longer-lived one where the imbalance occurs on the supply side.

Whereas the financial crisis and Great Recession sapped demand, the severe downdraft in oil prices that began in the second half of 2015 reflects an upsurge in non-OPEC production, driven primarily by the North American onshore market.

Investors who followed our lead and bought the dip in energy stocks in late 2008 and early 2009 booked huge gains, with the S&P 500 Energy Index soaring almost 40 percent from the end of 2008 to March 2010.

However, those who fell prey to recency bias—the tendency for humans to use patterns from the proximate past to predict the future—and bought energy stocks in anticipation of a V-shaped recovery in oil prices haven’t fared well this time around.

Based on our fundamental analysis of the oil market and lessons from the 1980s and 1990s, we repeatedly warned readers to resist the urge to buy energy equities that looked cheap on traditional valuation metrics. We underscored this risk during the energy sector’s spring relief rally, which far too many investors misinterpreted as an all-clear signal.

In January 2015, we first highlighted the potential for crude-oil prices to weaken toward year-end, an outlook that prompted us to add American Airlines (NYSE: AAL) to the Model Portfolio as a hedge and take sizable profits on SeaDrill (NYSE: SDRL) and Hi-Crush Partners LP (NYSE: HCLP). We also repeatedly urged investors to steer clear of offshore contract drillers and companies that produce silica sand for hydraulic fracturing.

Although we took losses on Vanguard Natural Resources LLC (NSDQ: VNR) and Memorial Production Partners LP (NSDQ: MEMP), cutting the cord on these and other stocks saved investors from considerable further downside.

We also repeatedly highlighted ProShares UltraShort Oil & Gas (NYSE: DUG) as an option to hedge portfolios with significant energy exposure and added Teekay Tankers (NYSE: TNK) and Royal Caribbean Cruises (NYSE: RCL) to the model Portfolio, two names that have benefited from lower oil prices.

The growing risk of a significant pullback in US equities next year means that investors should consider taking some of their profits off the table in these stocks and the convenience-store and packaging names we highlighted in the Demand Side Beckons and Revisiting Our Hedges.

However, the recent pullback in ProShares UltraShort Oil & Gas looks like a good buying opportunity for those who don’t have a position already, especially given our outlook for further downside in oil prices this fall and in early 2016.

After an almost 18-month bear market in energy prices and related stocks, we appear to be on the verge of an epic buying opportunity for a select group of upstream names that have the balance sheet and asset base to win market share and grow in an environment where prices remain lower for longer.

Our strategy, which we outlined in the Sept. 26 issue of Energy & Income Advisor, is based on lessons from the mid-1980s and early 1990s. Elevated US oil inventories, coupled with reduced demand during refinery turnarounds this fall and in early 2016, increase the likelihood of another selloff in crude-oil prices even though domestic output has started to roll over.

To take advantage of this coming buying opportunity, we’ve narrowed the universe to our top picks and setting dream buy prices for these stocks. Note that our strategy doesn’t aim to pick a bottom for these equities; rather, our goal is to identify valuations that represent good entry points.

 

Energy & Income Advisor

Your complete guide to energy investing, from growth stocks to high-yielders.

In October 2012, renowned energy expert Elliott Gue launched the Energy & Income Advisor, a twice-monthly investment advisory that's dedicated to unearthing the most profitable opportunities in the sector, from growth stocks to high-yielding utilities, royalty trusts and master limited partnerships.

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      Founder and Chief Analyst: Capitalist Times and Energy & Income Advisor

    • Roger S. Conrad

      Founder and Chief Analyst: Capitalist Times and Energy & Income Advisor