How to Play Oil Stocks as Crude Falls

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Just when it seemed like oil prices were rebounding — with Brent and West Texas Intermediate crude climbing 8% in Monday’s session — short sellers and profit-taking investors managed to to push the black fuel back down to the $40 to $50 range.

How to Play Oil Stocks as Crude FallsThe volatility in oil stocks continues to wreak havoc on investors who have oil stocks as a core portion of their portfolio and for fixed income investors who see dividends holding steady, yet are likely generating paper capital losses.

What should an investor of oil stocks do amidst this turmoil?

Oil Stocks: Everything You Need to Know

First, you have to understand a few things about oil, gasoline and energy. The world needs oil. Wars are fought over it. And the global economy is intrinsically tied to it, because oil infuses every aspect of human existence. There is nothing without oil.

Too much oil or too little oil, however, causes problems. The amount of oil on the market needs to be attenuated to in the just the right manner.

All it takes is for global psychology to be thrown a curveball, and suddenly expectations about oil production and consumption can be thrown into a tizzy, along with oil stocks.

What we’ve seen recently is sudden concern over China’s economy. If China’s economy is slowing down, then demand for oil (and oil stocks) will decline.

That means there may be an oversupply on the market, and when supply exceeds demand, prices fall. So when the Chinese stock market craters, it creates even more concern and psychologically helps push prices even lower. Which in turn takes oil down with it.

The supply problem is exacerbated by the oil producers themselves. They’ve spent years and billions of dollars developing technology that makes extraction easier and more efficient. Thus, exploration is becoming easier, so finding and extracting oil means it is easier to add to supplies. So what are they to do? Work against their own interests and not use all this technology they’ve spent money on?

Then we switch to countries that import oil. They see that prices are falling and jump for joy. Cheaper oil! Yay! So they rev up importing. That takes supply off the global market, and encourages the producing countries to produce even more oil to meet that demand, keeping supply up and prices lower. Those countries depend on oil revenue so they’ll churn out the volume to make up for the lower prices.

Meanwhile there’s 50 million barrels in floating supply on tankers.

So what’s an investor to do?

First, oil stocks of some kind should have a place as a core position in your long-term diversified portfolio. There will always be supply and demand imbalances. It’s part of the game. Look, we saw oil at $10 in the late 1990’s during the Asian financial crisis. Then it zoomed up to $140 in 2008 before cratering to $35 in the financial crisis.

This is always going to be the case. That’s why I always suggest one of the huge oil explorers and producers, like ExxonMobil (XOM), Chevron (CVX), ConocoPhillips (COP) and the like. You can’t go wrong over the long term with XOM, CVX or COP stock. They will survive no matter what, and you’ll collect a nice dividend along the way.

I also suggest the Energy Sector Select SPDR (XLE) because it holds all of the biggest names with exposure across the sector. If you like, you can even add the MarketVectors Oil Services ETF (OIH). OIH is more than 50% off of its 52-week high, and at some point it will rebound.

Bottom Line on Oil Stocks

Whether you already own oil stocks or want to add them, I would just buy in little pieces and plan to average down. If oil should break under $35, there’s a very good chance it could go to $20 or lower.

If it goes below $30, I think you should consider overweighting in energy stocks. If oil goes below $20, then I would buy oil itself because you are bound to see at least a 200% return over the next few years. Think about getting United States Oil (USO) for that play.

Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/09/oil-stocks-xom-cvx-cop-xle/.

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