We all know that the price of oil has collapsed, that the world is apparently awash in oil, and that Iran just told OPEC to pound sand regarding cutting output. Oil stocks are in a real mess.
Astute investors, however, know that when a sector is in such disarray, opportunity is not far behind. We are close to the point where opening small positions in some oil stocks will begin to make sense.
If you’ve been paying attention, you saw that oil briefly broke below $30 per barrel last month. However, oil prices rallied in a big way since then. A few smart bloggers believe this is due to short covering on the 3x leveraged inverse oil ETF — an ETF that uses futures contracts and derivatives to achieve triple volatility in the price of oil. If oil moves down 1%, the ETF moves up 3%, and vice-versa.
Apparently, several banks that hold these contracts had to scurry and make good on them, which meant lots of contracts had to be purchased, driving up the price of oil.
With that out of the way, oil is probably going to resume its downtrend, as will oil stocks.
I believe oil will find a bottom between $27 and $10 per barrel. Obviously, I hope it breaks all the way down to $10, but if it doesn’t, you do want to start accumulating oil stocks in very modest fashion around now. However, you want to be very judicious in how you do it. Expect that these oil stocks may fall even further. What you are doing is opening small positions so you don’t miss out if this is the bottom. You will be averaging down if it isn’t the bottom. That’s fine.
The point is that you want to establish some kind of position at these low prices because over the long term, oil will recover — probably back to $60 per barrel or higher — and you’ll want to enjoy those gains.
Ways to Move Into Oil Stocks
I think you can focus on four different securities, running the gamut from conservative to aggressive, and I’ll cover them in that order. You can open any size position you desire and add in any amount. Personally, I think the safest bet is to decide how much you want to invest in total, then spend 20% of it buying now, and add another 20% every time oil falls another $4. So you’ll buy at $27, $23, $19, $15 and $11.
The safest bet you can make is to just buy Exxon Mobil Corporation (XOM), the granddaddy of oil stocks. XOM stock is actually holding up fairly well, and XOM will recover faster than any other security. However, it will also provide the most modest gains.
Next up is the Energy Select Sector SPDR (ETF) (XLE). With XLE, you get exposure to the best-in-class oil stocks. If there’s an oil stock that you’ve ever heard of, chances are that XLE ETF has it within its portfolio. In fact, the top 10 holdings represent two-thirds of XLE stock holdings, and you’ll get a big exposure to XOM stock (which is 19% of assets).
If you want to get a bit more aggressive, move on to the Market Vectors Oil Services ETF (OIH). Oil services are dependent on activity in the broad energy sector, which itself is dependent on oil prices. OIH stock is 80% off its all-time high. This is a great place to enter, and again, you are getting best-in-class holdings in the sector, of which the top 10 positions make up 75% of the fund.
Finally, the most aggressive choice would be to buy oil itself. You can do this many ways, but buying the PowerShares DB Oil Fund (ETF) (DBO) is probably the best bet. Were you to average in as suggested, and were oil to rebound to $60, you’d make 3x on your money.
If you are super-aggressive you can buy the 2x and 3x leveraged long versions of that ETF. The 2x is ProShares Ultra DJ-UBS Oil ETF (UCO) and VelocityShares 3x Long Crude Oil ETN (UWTI). However, if you go this route be advised: You can lose a lot more money than you originally invest when working with leveraged funds, so invest with extreme caution.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he was long OIH and XLE. 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 atTheLibertyPortfolio@gmail.com.
