Special Report: Six Ways to Profit From the One-Two Punch of Soaring Oil Prices and Zooming Inflation

By William Patalon III
And Jason Simpkins
Money Morning Editors

Oil prices have resumed their northward climb. And inflation has returned to the American lexicon for the first time in decades.

For U.S. consumers, there's no way to dodge the financial fallout of that economic one-two punch.

But for U.S investors willing to make some shrewd moves now, Money Morning can show you six ways to offset that high-priced pain with some profit plays that will continue to rise in value as oil prices and inflationary pressures continue to escalate.

Let's first understand the battlefield we're going to use for our profit-generating counterattack.

Escalating Energy and a Diving Dollar

Crude oil for July delivery traded as high as $139.12 a barrel on the New York Mercantile Exchange Friday - an all-time record - after a worse-than-expected employment report spooked investors and the European Central Bank (ECB) threatened to start raising interest rates. The U.S. dollar was crushed as a result.

For the day Friday, July crude oil soared $10.75, or 8.4%, to finally close at an all-time high of $138.54.

For the week, the contract climbed 8.8% on the NYMEX.

The U.S. payroll numbers really spooked investors - and established fears that so-called "stagflation" would return to the U.S. economy for the first time since the 1970s.

The still-weak greenback fell more than 1% to $1.5674 per euro in late-afternoon trading - its lowest point since May 28 - after the unemployment rate jumped to a higher-than-expected 5.5% in May, up from 5.0% in April, as employers put 49,000 Americans out of work.

Employers have now cut payrolls for five straight months, leaving the jobless rate at its highest level since October 2004. The unemployment rate is expected to reach at least 6.0% by early next year.

U.S. stocks were eviscerated Friday. The Dow Jones Industrial Average plunged 394.64 points - or 3.13% - to close at 12,209.81. The tech-laden Nasdaq Composite Index skidded 75.38 points, or 2.96%, to end the day at 2,474.56. And the broader Standard & Poor's 500 Index plummeted 43.37 points, or 3.09%, to finish the week at 1,360.68.

Clearly a number of catalysts are at play here.

But the key catalyst is the nose-diving dollar.

The dollar's decline Friday followed an equally dramatic tumble Thursday, when the greenback fell 1% on news that the European Central Bank had hinted at an increase in the benchmark European Union (EU) interest rate.

"It is not excluded that, after having carefully examined the situation, that we could decide to move our rates a small amount in our next meeting in order to secure the solid anchoring of inflation expectations," ECB President Jean-Claude Trichet said at a news conference.

The ECB has remained hawkish on inflation, holding its key lending rate steady, even as the U.S. Federal Reserve cut its benchmark Federal Funds rate seven times in a desperate bid to revive the U.S. financial-services sector while also averting a recession.

Between Sept. 4 and April 22, the dollar plummeted 14% against its European counterpart as a result of the divergence, and the $1.6019 it reached on April 22 was an all-time low.

The Greenback "Head Fake"

After reaching that nadir, the greenback posted a slight 3% rebound, hitting a five-week high on May 2 after Fed Chairman Ben S. Bernanke signaled a pause in the U.S. central bank's rate reductions.
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But in a May 8 financial commentary, Money Morning Investment Director Keith Fitz-Gerald warned investors that this dollar rally - which was receiving of attention on Wall Street - was "a head fake of legendary proportions."

Recent events have derailed the greenback's rally... and validated Fitz-Gerald's warning.

Friday's sagging employment figures compounded the negative effect of Trichet's comments by fueling speculation that the U.S. Federal Reserve would be unable to reverse course and start raising rates - which is what most analysts have been predicting - without causing the U.S. economy to collapse.
Should the ECB raise its rate in July, the results could be devastating for the dollar, which could slip into an out-of-control spiral.

"The big shock was the rise in the unemployment number," Samarjit Shankar, a foreign exchange analyst at The Bank of New York Mellon Bank Corp. (BK), told Bloomberg News. "It damps the outlook for a tightening in U.S. rates and strengthens the case for $1.60 [against the euro]."

Climbing Commodities

Commodities, priced in dollars, soared on the greenback's freshly exposed vulnerability.

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Make 155% From Oil's Record Run

Oil hit an all-time record $139 per barrel on June 6. Modest projections now show that it could reach $187 in the next 12 months. But buying "Big Oil" is the least efficient way to make money. Most of their profits are being pumped into exploration - specifically one company. This powerhouse has already spiked 63% in the first quarter. And now its oil-extracting technology has it positioned for additional gains of 155%.

Access the full details in your free report.

"Many investors used the latest sell-off in the dollar as an excise to get back into the [oil] market," Andrey Kryuchenkov, an analyst at Sucden (U.K.) Ltd. told Bloomberg. "Concerns that demand is flattening in the near term have been overshadowed by persistent inflationary worries."

Crude oil for July delivery jumped $5.49 a barrel - or 4.5% - on Thursday before extending its gain to reach its record close at $138.54 Friday.
[Money Morning's Fitz-Gerald - one of the first investment gurus to predict triple-digit oil prices - recently boosted his target price for crude oil from the $187 level he projected back in December to a new level of $225 a barrel.]

Gold climbed 2.7% on Friday, returning to the $900 an ounce mark as the dollar stumbled.

"Gold rallied in line with moves down in the dollar."  David Thurtell, analyst at BNP Paribas SA (OTC: BNPQY), told Reuters.  "The worry is if unemployment is climbing, then mortgage defaults and subprime losses rise."

Money Morning on Friday published a research report reiterating its earlier prediction that gold prices could reach $1,500 - or even $2,000 an ounce - thanks to the powerful global trends that are propelling many commodity prices to new record highs.

Gold is traditionally used as a hedge against financial uncertainty. It also makes dollar-denominated commodities cheaper for holders of other currencies.
Nevertheless, until the Fed reverses its monetary policy strategy and increases interest rates - an inevitability, predicts Money Morning Contributing Editor Martin Hutchinson - gold remains one of the best investment bets available in an uncertain economic climate.

Indeed, we're going to look at profit plays with two kinds of gold - conventional gold, also known as the "yellow metal," and so-called "black gold," another term for crude oil.

Let's start with oil.

The "Black Gold" Triple Play

Money Morning's Fitz-Gerald has developed a three-pronged strategy for investors who want to capitalize on rising crude-oil prices. Here it is:

Go Deep: With oil prices now in record territory, oil companies are exploiting resources previously considered too expensive - or too dangerous - to tap into. When oil was trading in the range of $20 to $30 a barrel - creating meager profit opportunities for so-called "Big Oil" - companies refused to finance any project that couldn't lead to oil production at a cost of $10 to $15 a barrel. Needless to say, rising oil prices have changed that corporate outlook. At nearly $140 a barrel, companies are looking to cash in with an array of exploration opportunities.

In early December, Lehman Brothers Holdings Inc. (LEH) predicted that oil producers would spend a record $369 billion on energy projects this year, 11% more than in 2007. The benchmark West Texas Intermediate crude oil was trading at about $88 a barrel at that time, says Canadian National Railway Inc. (CNI). That means oil prices have risen 56% since then: So it's a safe bet that Big Oil's investment plans have increased, too.

In December, when oil was trading at $90 a barrel, Fitz-Gerald predicted that oil prices would reach the $187 a barrel level in 24 to 36 months. In March, as part of the ongoing global-trends research that lead to the creation of Money Morning's just-published "Investor's Playbook," Fitz-Gerald recommended StatoilHydro ASA (ADR: STO), an integrated oil company headquartered in Norway. Fitz-Gerald still favors the company; in fact, with oil prices having risen so sharply - and expected to climb further still - Fitz-Gerald likes the stock even more now than he did in March.

And he's not alone: In its just published "Special Issue Investors Guide," in an article titled "The Government Oil Play," Forbes magazine detailed Statoil's substantial investment potential.

StatoilHydro is the result of an October merger between Norway's Statoil and Hydro's oil-and-gas division. What resulted from that combination is now an integrated oil-and-gas player that focuses on the exploration, development and production of oil and natural gas from the Norwegian Continental Shelf. It's now the world's largest energy operator in waters more than 100 meters deep and produces, on average, 1.7 million barrels of oil equivalent per day. It has proven reserves of more than 6 billion barrels of oil, has operations in 34 countries, and is expanding aggressively to diversify internationally.

Back in March, the company announced plans to spend as much as $2.1 billion on operations in Brazil and the Gulf of Mexico. It bought the 50% stake it didn't already own in Peregrino, a heavy oil field in Brazil, and 25% of the deep water Kaskida discovery in the Gulf of Mexico, from the Texas-based Anadarko Petroleum Corp. (APC).

StatoilHydro saw its year-over-year net income rocket 62% in the first quarter as realized oil prices rose 42% on a year-over-year basis. The company also surprised Wall Street, besting estimates by 34.29% for the quarter, the Zacks.com unit of Zack's Investment Research reported. Statoil reported profits of 94 cents per share, trouncing analysts' estimates of 70 cents per share. Zacks.com has given Statoil its No. 1 ranking, which is the equivalent of a "Strong Buy."

According to the Zacks.com analysis, StatoilHydro has a forward Price/Earnings (P/E) ratio of 11.05. The company has an outstanding five-year average return on equity (ROE) of 38.07%. It also is conscientious of its shareholder base, and has been distributing some of its excess cash to stockholders as dividends. In mid-May, Statoil paid out a dividend that was equal to $1.659 per share in U.S. dollars - an increase of 9% over the dollar-equivalent dividend of $1.527 per share paid out in May 2007.

For this year, analysts are projecting year-over-year earnings growth of 38.09%. Statoil itself is bullish about future exploration in 2008.

"Several new fields have been added to the StatoilHydro upstream production portfolio since the turn of the year, for example Volve and Gulltopp on the Norwegian Continental Shelf (NCS) and the deepwater Gunashli field in Azerbaijan," Statoil Chief Executive Officer Helge Lund said. "We continue to build long-term growth through an extensive exploration program and active business development. We have signed an agreement to take over the Peregrino project in Brazil. This has strengthened our position in an exciting upstream region."

As the prices of crude oil and natural gas continue to rise, brokerage analysts have been raising estimates for the full year. Consensus estimates for the year are up 11% in the last 30 days as three out of four covering analysts raised estimates to an average of $3.51 from $3.16 per share.

Target China: According to Fitz-Gerald, every investor must have a China strategy. And that especially holds true for the energy sector. CNOOC Ltd. (ADR CEO), China's offshore oil and natural gas explorer, is a prime candidate to fulfill both the "China" and "energy" portions of your investment portfolio.

At $171.28, the shares are closer to their 52-week high ($218.20) than they are to their 12-month trading low ($90.58), and are on the pricey side, Fitz-Gerald says [The shares are trading at a current P/E of 18.33, but their forward P/E is only 8.49, according to Google Finance]. But as a long-term play on China's emergence as a superpower and the expected continued increase in global energy prices, investors with the patience to let such a strategy play out may find this a profitable pick, Fitz-Gerald says.

When Goldman Sachs Group Inc. (GS) upgraded CNOOC's shares to "Buy" from "Neutral" back in March, the investment bank said it made the move because its internal outlook for the company was much more aggressive than the Wall Street consensus. Given the weak dollar, CNOOC could also be on the prowl for acquisitions, which would further boost its earnings potential, Goldman reported.

Interestingly, in its report on Statoil, Forbes made a point of mentioning CNOOC as another solid government-controlled oil play with substantial, low-cost reserves.

Explore Your Alternatives: As Fitz-Gerald likes to say, "alternative energy is an alternative no longer." Just as the massive upward move in energy prices is jump-starting deepwater drilling, it is also supercharging innovation, including both increased research into alternative fuels for automobiles as well as boosted outlays for spending on alternative energy sources for electricity production for towns, cities and countries.

Ultimately, the United States government is going to have to get serious about promoting alternative-energy research - much more so than it is now, Fitz-Gerald says.

That hasn't happened, yet. But don't let that deter you: Even now, investment opportunities abound.

And yet, investing neophytes need to understand that this arena can be as tricky as investing in raw Internet startups. Unless you really understand the technology and have a grasp on each company's financial position, you never know which firms will thrive or founder. For that reason, it's a sound strategy to turn to fund-management firm with a solid alternative-energy savvy of its own. Indeed, there are a number of exchange-traded funds (ETFs) that focus on "clean" technology. But the one we like best is Fitz-Gerald's choice top choice: The PowerShares WilderHill Clean Energy Fund (PBW)

Go for the Gold

In the gold-research report we published last week, Money Morning highlighted six gold plays to look at while the "yellow metal" was down from its highs. Gold has rebounded a bit, but remains a key profit opportunity - especially if inflation, or even stagflation, is taking hold. It should also help that economic uncertainty is escalating.

However, since the economic outlook has grown more uncertain, we've decided to pare those six profit plays down to three - giving you the very best of the best. And we've highlighted them here.

Here are the top three picks:

  • The StreetTracks Gold (GLD) exchange-traded fund (ETF), which tracks the price of gold directly, making it the simplest way to invest in the yellow metal via an ETF. And with a market cap approaching $17 billion, this fund has ample liquidity.
  • Barrick Gold Corp. (ABX) is a Toronto-based company with mostly North American production, as well as properties in South America and Africa, and some copper and zinc add-ons. It has a $38 billion market capitalization, so there's plenty of liquidity. It has a trailing Price/Earnings ratio of 19.27 and a forward P/E of 15.11. By gold-mining standards, this company has a substantial presence, is reasonably valued, and has little political risk. The company also recently sent some very bullish signals to the market and reasserted its confidence in meeting its 2008 output target of up to 8.1 million ounces of gold. [For more details, check out a recent related story about Barrick Gold]. One other key point: As big backers of income-producing stocks, we liked Barrick's announcement that it was boosting its June dividend by 33%.
  • Yamana Gold Inc. (AUY) is another U.S.-listed/Canada-based company, but this one does its mining in Brazil, Argentina, Chile, Honduras and Nicaragua. It has a market cap of $9.7 billion and a trailing P/E of 39.17, but its forward P/E is only 13.91. Despite its geographic reach, it faces only a medium geopolitical risk. Expect the company to double production to 2.2 million ounces per year by 2012, primarily in Brazil and Argentina.

Rest assured, Money Morning team of global finance experts will continue to watch and analyze energy prices and inflationary forces and to report to you what we find. And as demonstrated here, we'll also find ways for you to protect yourself and your portfolio from these forces, and wherever possible, to profit, as well.
[Editor's Note: For a related story on the outlook for gold by noted investing guru Peter D. Schiff that also appears in today's issue, please click here.]

News and Related Story Links:

  • Money Morning Financial Commentary:
    A Currency Conundrum: Beware of the U.S. Dollar's "Head Fake" Rally.

About the Author

Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press.

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