There has been no shortage of red ink in the market lately.
This latest action will further depress oil prices, as the rash of bad news translates into even more knee-jerk projections of reduced demand.
Of course, it's much too early to make such predictions based on the news, but the pundits do it all the time.
In any case, we are now in a downward movement that will end only when the market manipulators say so.
When this happens, individual investors always take it on the chin.
That's why I want to take a moment today to outline for you the strategy I use for my Energy Advantage and Energy Inner Circle subscribers.
Of course, if we could time the market, or invest in perfect hindsight, we wouldn't need an investment strategy.
But while some of the largest investment banks are getting it (very) wrong these days, crystal balls seem to be in short supply.
So what should we do?…
Well, there are three overriding considerations you must keep in mind when approaching the energy sector in an environment like this.
- First, know that this, too, shall pass. Take a deep breath and relax.
- Second, keep your powder dry. There is no point in chasing uncertain shares in an uncertain market, simply because some talking head on TV says they are undervalued. In the current situation, almost 80% of the shares I follow are well below market value. However, until the market finds equilibrium (something it always does, by the way), the undervaluation means little. Nibble when you feel targets are cheap enough, but never go all in.
- The third point is the single most important thing to remember here. A situation like this one demands that you preserve your investment capital. Uncertainty is always the mother of discretion. The energy sector has been hit harder than the market as a whole for much of the last six weeks. That means you need to set up an exit strategy and stick to it.
Our Energy Strategy Works to Preserve Both Principle and Gains
The approach is easy and straight-forward. It involves establishing a pre-determined trailing stop and then selling your position if the asset trades through that stop.
No questions asked.
A trailing stop will establish a level, say 35%, from the highest price the stock reached while you have owned it and set that as a pricing limit for the sale.
Now, there are two more things to keep in mind here.
For shares that have performed well, a trailing stop will sometimes oblige you to sell even though the stock is still making your portfolio a profit. Remember, this is not only about paring losses, but also preserving your original investment and even locking in some of those gains.
You will need to revise your trailing stop when your holdings advance, too. You are not setting an exit from the price at which you bought the shares, but at the best subsequent price reached (based on the closing price, is how we do it).
The "fire sale" mentality hitting a much-oversold market like this one will re-inflate prices… and fast.
It may seem for a while like every choice will be a winner – like shooting fish in a barrel. (I have never really understood this particular metaphor; did people actually do this?)
However, the objective in a recovering market is to structure a sustainable exposure moving forward. In energy, that means a balance between producers, midstream companies, and refiners/downstream distributors, in oil and gas first.
This is because the entire sector will take its departure from what occurs with the prevailing energy sources. The initial recovery will be in those sources that have the most immediate connection to, and best reflect the condition of, broader economic and market considerations.
Whatever reflects the downward pressure in a market will do the same when that market moves upward. And if energy in general, but oil and natural gas in particular, has declined more than the market as a whole, it will respond stronger than the market, on average, during a recovery, too
There is a pervasively permanent reason for this.
You can probably guess what it is.
The vast majority of forward indicators (the ones we look at when estimating where an economy is heading) are energy dependent.
That guarantees an upward momentum will be fueled (no pun intended) by early spikes in the value of companies that provide the energy. Those will be oil and gas, initially.
Yet keep in mind you are looking for a sustainable mixture. This will require some balance in your portfolio, and that balance needs to be flexible.
For example, there will be room for alternative and non-hydrocarbon plays, especially if they have a direct relationship to providing rising levels of power generation (also needed during a recovery).
But don't balance just for the sake of balancing.
Renewables – such as solar, wind, and geothermal – certainly have a future and will be components in the developing energy mix. But they remain trouble right now, and they may also have a harder time getting untracked once we reach the next bottom.
We will come back to these matters again as circumstances stabilize.
In the meantime, remember consideration No. 1: Take a deep breath and relax.
Related Articles and News:
- Money Morning:
Germany Set to Invest $260 Billion in a Renewable Revolution
- Money Morning:
It is Deja Vu All Over Again in the Energy Markets
- Money Morning:
How to Profit on the Natural Gas Surplus
- Money Morning:
Oil Prices and the Death of Greece
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.