Monday, December 29, 2014

Energy Sector Outlook

The recent fall in gas prices has been a direct effect of supply and demand trends in global crude oil markets.  A recent oversupply has been caused by the emergence of fracking in the U.S. and Canada.  This problem has been compounded due to the fact that OPEC (the Organization of Petroleum Exporting Countries) has been adamant about maintaining their current levels of production.  Some say they are choosing to do this in order to squeeze out some U.S. suppliers and uphold the market share of oil coming from the Middle East.  Slowing economies in the Eurozone and China are also causing many to believe that there will be pressure on the global demand for oil.

As for the effect on oil companies, this recent drop has caused broad negative performance in the sector.  During oil’s 47.8% tumble since 06/30/14*, the SPDR Select Energy Fund (NYSE:XLE), which broadly represents U.S. oil companies, has fallen 19.1%.  Moving forward, however, some companies will be able to adapt to these changes much better than others.  For example, smaller players in the U.S. fracking revolution are now being squeezed the hardest, as many did not anticipate selling crude oil at these levels.  Wade Financial Group has owned a number of energy related stocks in 2014. Recently, we transitioned out of some of these smaller, more volatile companies, into larger and more stable names in anticipation of further trouble in energy markets.  We continue to selectively hold some energy companies in our Paid to Wait® and Paid in Advance® strategies due to their strong financial position and durable competitive advantages. 

Moving forward, it would be nearly impossible to try and predict an exact bottom for oil prices.  We feel strongly, however, that current prices cannot be maintained for the long-term.  Some financial pundits have already declared that oil prices are nearing a trough.  We would need to see some stability in the oil markets first, but there will be a time when many of these companies can be purchased at a true bargain. Until that time, we have positioned our accounts to hold only companies that we feel are best suited to ride out the most recent wave of volatility.

Commodities are in bear markets.  No one can predict where the top is for the U.S. market or where the bottom is when an asset class like energy is in a bear market.  While self-directed investors are typically afraid to buy asset classes when they are on sale, 2015 may be a time that they should consider breaking their own rules and buying beat up asset classes at bargain prices.  Most notable to consider are commodity and energy sectors--emerging markets as well, but energy may potentially snap back quickly.

Bear markets are typically shorter than bull markets.  By many measures, oil is currently priced under the cost of production.  On a short term basis, this may continue (6-18 months).  On a longer-term basis, oil is potentially destined to rise significantly from current levels.

Over the short term, such contrarian investment positions still may experience further downside momentum and works against investors.  Our allocation to energy and commodity sensitive investments and asset classes may grow further as we enter 2015, as opportunities present themselves.

* As of 12/26/14

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