When Higher Energy Prices are Good
No one wishes for higher energy prices. Everything is tied to some greater or smaller extent to the cost of oil and natural gas. Why, this editor just recently heard that the maker of Oreos was going to have to raise the cost of those delicious cookies by several cents per package because of increased transportation costs! (Why only Oreo cookies were singled out by the manufacturer, heaven only knows.) The cost of seemingly everything from the obvious (driving your car) to the unobvious (buying fertilizer for your lawn) depends to some extent on the price of oil.
And there is little reason to hope for improving conditions over the intermediate term for lower energy prices. This winter may be a little colder than average, pushing up the cost of natural gas and heating oil. While economists argue (logically) that higher energy prices reduce consumption, there is little evidence that this holds true (yet) in America, the energy hog of the world.
We all know that there aren’t any more dinosaurs dying off to produce extra oil for us to consume (dead dinosaurs = oil, according to our infallible high school science textbooks of old—there must have been a lot of dinosaurs to have created the amount of oil we’ve found to date!) That only leads to the expectation that prices will continue to move up over time, until either a) consumption slows and/or reverses course, b) alternative energy sources like wind, solar, etc. begin to replace oil-based energy consumption or c) we suddenly discover a lot more oil and gas. How much are you willing to bet on any of these scenarios happening any time soon?
“If you can’t beat ‘em, join ‘em,” so the saying goes. If we accept as fact that energy prices will continue to rise, then we can find a way to profit from that rise (assuming we are correct in our assumption). If you were invested in The Prudent Investor’s Model Stock Portfolio this year, you should have been smiling as gasoline prices hit $3.00/gallon, that is, if you recognized the connection between that event and the doubling in price of one of our stocks, Giant Industries Inc. (GI). Currently almost 30% of our model portfolio is invested in companies that stand to gain financially as energy prices remain high.
Taking Advantage of Volatility
The caveat with our logic above is that the “secret’s out.” That is, The Prudent Investor is not exactly the only newsletter to realize there’s money to be made in energy companies (surprise). Once everyone believes he or she can make money in this sector, the stock prices can plateau or worse. That is one reason we expect higher-than-usual volatility in the energy sector over the next several months. In some respects, we have already seen it (witness CHK dropping recently from a high of $40 to below $30 when there was no negative news on the company).
Given The Prudent Investor’s proprietary methodology for stock selection, volatility is actually a good thing. Our model automatically exploits volatility by forcing stock purchases when certain stocks decline in price, and forcing us to sell stocks that have risen sharply in value. A recent example of benefiting from volatility in a non-energy-related stock is FMD. In early October this stock plummeted on potentially bad news—news which turned out not to be so bad after all. Using our portfolio model, we were cued to make purchases at $22/share for several clients. (This trade unfortunately did not make it into our newsletter because we only publish monthly.) Several weeks later around at the end of November the stock was trading at $33 or so. The portfolio model called for selling most of the shares which had been purchased at $22/share, which we did at a nice 50% gain.
FMD merely illustrates that volatility can be a positive rather than a negative if you have a means of acting on it. If you take advantage of The Prudent Investor’s buy/sell recommendations and portfolio rebalancing each month as represented in our Model Stock Portfolio, you should benefit from the volatility of the market as well.