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The Bull Market in Energy Remains Intact


Prices will likely to be all over the map in coming months, however, particularly as investors worry about a crash.

Although there might be fundamental reasons why some energy stocks outperform others, none of the obvious ones in these cases have anything to do with what should ultimately drive their value: the ability to increase production and reserves.

Rather, prices seem to be dictated by perceptions based on emotion. Selling has begotten more selling, which has sent some stocks tumbling. And buying has triggered more buying, which has pushed other stocks higher regardless of the strength of the underlying business.

That's what I call the triumph of momentum over value. The resulting distortions never last long. But they can create havoc and cause those who get caught up in them to make very bad investment decisions.

The current weakness in energy prices is mainly driven by worries about global economic growth, and specifically concern that demand in China will continue dropping in the coming months. Additionally, the US energy rig count has dropped to its lowest level in 18 months after declining five months in a row, as US oil production has hit a 17-year high on productivity gains and inventories have surged.

Some have gone so far as to proclaim the end of the bull market for energy that began in 1998, when oil traded under $10 a barrel and natural gas sold for less than $1 per million British thermal units (MMBtu). Forgotten is the fact that should oil fall below $50, the unconventional production responsible for current output levels would no longer be economic and would, therefore, be virtually shut down. That's what happened to natural gas, whose prolonged retreat below $5 per MMBtu has caused producers to suspend new drilling for that fuel.

Finally, US demand–largely counted out since the 2008-09 Great Recession–has been recovering in recent quarters. And if today's report of surprisingly strong growth in gross domestic product (GDP) signifies a trend, it could start surprising a lot of people very quickly.

The bottom line is energy prices are likely to be all over the map in the coming months, particularly as investors continue to worry about a reprise of the 2008 crash. But at its core, oil is still well, and so are stocks of solid producers, be they MLP, trust, super oil or former Canadian trust.

In fact, these stocks remain an essential part of any income-oriented portfolio. The best energy companies are not just growing enterprises that are boosting dividends and shareholder value over time. They also offer the best possible hedge against any resurgence of inflation, since energy would be a core component of any future inflation.

The key to successfully investing in dividend-paying energy stocks is to follow the value. As long as a company is increasing reserves and output consistently over time, any setback is a buying opportunity.

This article by Roger Conrad was originally published on Investing Daily.

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