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My Favorite Sector for Summer: Energy

Energy — and in particular, oil — has been described as the lifeblood of modern society. Well, if this is true, then there’s been plenty of lifeblood bloodletting lately on Wall Street. Stocks and exchange-traded funds tied to the oil and natural gas industries have been flowing red for months, as investors have sold positions on fears that a slowdown in the global economy will continue to keep energy demand under wraps.

As the famous British nobleman Baron Rothschild once said, “The time to buy is when there’s blood in the streets.” Based on this adage, the time to buy the lifeblood of modern society is right now — and that’s why energy is my favorite sector for summer 2012.

To be certain, there has been a lot of pain in energy stocks of late. But if you’re a smart investor with a time horizon of more than just a few weeks, you’ll turn that pain into your gain by building positions in some of the best energy stocks and funds out there.

The Select Sector Energy SPDR (NYSE:XLE) is one of the biggest — and one of the most beaten-up — ETFs in the energy space. The fund counts such stalwart energy concerns as Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), Schlumberger (NYSE:SLB), ConocoPhillips (NYSE:COP) and Occidental Petroleum (NYSE:OXY) among its top holdings.

XLE is down more than 15% during the past three months, as investors have lost their appetite for energy-sector risk. Yet it is precisely because of this pullback in the sector that I think makes it such a good bargain right now.

Consider that the stocks in XLE are, on average, trading at about 11 times earnings. That’s very cheap, especially when you realize you’re buying some of the most profitable companies ever. Also consider that you’re getting a yield of about 1.5% with XLE, which, while not huge, still isn’t income you should sneeze at.

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Of course, the really attractive aspect of XLE can be seen when we look at the technical picture. In the chart to the right, we see that stocks in the space have plunged below both the 50- and 200-day moving averages in May. We also can see that the latest action in stocks shows the beginning of a bounce. This same sort of pattern took place in August, and again in November 2011. Each time that happened, buyers willing to stay in for the long haul were rewarded with subsequent upside.

For those who prefer to own individual stocks as opposed to ETFs, both Exxon Mobil and Chevron represent outstanding buying opportunities.

Exxon shares are down nearly 6% during the past three months, although they remain trading above their 200-day moving average. At a P/E under 10, and a yield of 2.8%, the pullback in XOM just means you get to own this energy behemoth at an attractive discount.

The same is true of Chevron. This stock actually is trading below its 200-day moving average, and it’s down nearly 9% during the past three months. However, with a P/E of 7.3, and a dividend yield of 3.6%, you’re able to own this profit juggernaut’s shares at ridiculous bargain, too.

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The other beaten-down subsector in the energy space I like this summer is natural gas. Like oil, increased supply and subdued demand have teamed up to cause prices in the space to plunge. Unlike oil, there’s already been a strong resurgence off the 2012 low in natural gas, which can be seen in the accompanying chart.

One way to play the long-term future of natural gas is with the Market Vectors Unconventional Oil & Gas ETF (NYSE:FRAK). This ETF holds companies involved in the unconventional production of crude oil and natural gas, a large part of which comes from shale output. FRAK only made its debut in February, but it already has attracted more than $17 million in total assets.

Like oil-related energy stocks, the natural gas sector is for investors with more than just a short-term time horizon. And like stocks in the energy space, the current stocks pegged to the natural gas sector are not for those looking to make a quick trade. Rather, I look at FRAK as a way to get in on the ground floor of a sector with tremendous long-term growth potential.

New technologies enabling U.S. companies to cost-effectively increase exports of liquefied natural gas promises to be a big boom for stocks in the space, many of which are held in FRAK. According to the Energy Information Administration’s Early Release Annual Energy Outlook report for 2012, the United States is projected to become a net exporter of liquefied natural gas by 2016.

If the demand for natural gas begins to increase, investors who build positions in the sector now are likely to be smiling by the time I write about my favorite sector for the summer of 2013.

More from this series:

As of this writing, Jim Woods did not hold a position in any of the aforementioned securities.

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