I would like to think that the world has changed in 30 days, and that the energy and commodity bull market we have experienced the last five years was a mirage, but like I said in August when oil prices were nearing $80/bbl, a pullback in energy was expected going into the mid-term election. What we are experiencing right now is the full impact of the "Magic."
The demand side of the equation has not suddenly disappeared. The industrial revolution taking place in China and India has not come to a halt. As the old saying goes, "A thousand men can be swayed by their prejudices faster and easier than one man can be persuaded by reason".
The truth of the matter is investors are being whipsawed by the sudden decline in energy and commodities once again. We saw it in 2002, in August 2004, in May and October of 2005, and again in May of 2006.
As these past corrections took place, I watched momentum managers of mutual funds sell energy at the bottom, only to buy the stocks right back again at the top.
There are three area's that we would like to focus on; energy, gold, and commodities.
Corrections, even sharp corrections, are perfectly normal in commodity led bull markets. As is often the case, a bull market in any sector can drive stocks to severely overbought levels. This usually occurs when the herd mentality begins to jump into a market that is reaching new highs. Sell-offs or corrections are healthy in alleviating severely overbought conditions, and helps in creating a healthier upward trend.
ENERGY
We are particularly interested in energy as a value play since many high quality energy stocks are being priced like oil is trading at $35/bbl. We think oil will trade between $55-$65/ bbl since the oil industry needs prices of $55-60 to justify new investment. Without new investment, exploration is not economically feasible.
If oil prices remain around the $60/bbl mark, earnings estimates will come down, but the amount of money the companies will earn will still be substantial. Also, the P/E ratios of companies like Valero (VLO), Marathon (MRO), and Sunoco (SUN) will still be far below the average P/E in the S&P 500.
Natural Gas is the new whipping boy in the markets these days, and this should be a heads up for an alert contrarian. We still like companies like Chesapeake Energy (CHK), and BRG Group (BRG) at current levels.
Sure, oil prices could trade down to the $30-$35/bbl level for a brief period of time, but it would take another 9-11 type situation to cripple the economy and make demand fall apart.
GOLD
Based on its current price action we would not be surprised to see gold trade in a range of $470-$530 in a climax sell-off. A 50% retracement would put the midas metal back around the $495 level, and this is certainly a possibility.
Given the bearish outlook for the US Dollar, we feel that gold provides a nice hedge against any future declines.
Here is our favorite investment in Gold;
streetTRACKS Gold Shares ETF (GLD)
COMMODITIES
For almost 100 years, there has been an inverse relationship between the direction of stocks, and the direction of commodity prices. In recent months, as commodities rallied, the stock market held up remarkably well. We think this happened because the market was anticipating a correction in commodities. The market was right.
Given the recent fiasco surrounding hedge fund participation (I.E- Amaranth) in commodities, the recent sell-off in the CRB index is showing traces of panic by speculators and momentum players.
At current levels we are buyers of select commodity stocks and funds since we believe that this sell-off is reaching what could be a major bottom. Technically the CRB index could reach the 250 level as a panic low, but I like to dollar cost average into a position since I don't know if that low will be reached.
Here are some investments we like in the commodity area;
Iron Ore: Rio Tinto (RTP), BHP Billiton (BHP), and Cleveland Cliffs (CLF)
Coal: Arch Coal (ACI), Peabody Energy (BTU).
Agriculture: Monsanto (MON), Potash (POT), Archer Daniels Midland (ADM)
Uranium: Cameco (CCJ)
Commodities Fund: PowerShares DB Commodity Index Tracking Fund ETF (DBC)
