Energy stocks are on fire. But this move is just getting started. They could be up another 50% a year from now, in the “melt up” scenario I foresee for the economy. I don’t know what they will do tomorrow or next week, but any weakness is an opportunity to add. Here are six reasons why.
Reason #1. Energy names are a “melt up” cyclical play. Since the March lows, I have been emphasizing cyclical companies in my stock letter Brush Up on Stocks, and they have done quite well. Cyclicals outperform as we go to growth and more growth, from recession. That’s my outlook, because of stimulus and progress on the virus.
Reason #2. Energy stocks still have big room to move. A 50%-60% move up from here would only get them back to where they were before Covid-19. If the economy really takes off, they could even surpass that.
Reason #3. Flights will resume. Jet fuel is one of the biggest demand drivers of energy usage. Travel will rebound as the vaccines, therapies, and stimulus do their work.
Reason #4. Energy stocks look cheap. The sector recently traded at a price to book ratio below one, and it has one of the lowest valuations relative to the S&P 500 in decades.
Reason #5. The crowd has yet to rush in. Generalists and retail investors still are not buying in. When they do, that’ll be another source of demand for your stocks if you buy them now.
Reason #6. There are issues with long-term supply.
Collectively, oil wells naturally lose about 3.5% of production output per year. Energy companies have to keep investing to keep up. Instead, they have suspended investments in development. That will weigh on production over the next two to five years, about the time it takes to develop wells once the investment decision is made.
Meanwhile, North American natural gas (NG) prices could move up sharply this winter for several reasons.
* Liquid natural gas (LNG) exports from the U.S are rising, draining supply.
* The amount of natural gas produced during fracking for oil in the U.S. is down a lot, because of low oil prices.
* The NG rig count is low, and it takes time to bring new rigs online.
* We may see an unusually cold winter, according to WeatherBELL Analytics.
How to play this? I’ve been suggesting Continental Resources (CLR) in my stock letter in the $12.50 range in September and October, and it is already up 34%. I continue to hold. I’ve also suggested several other energy names in my letter that are doing well. For ETFs, consider Energy Select Sector SPDR Fund (XLE) and SPDR S&P Oil & Gas Exploration & Production (XOP).
And I suggested several energy stocks ahead of the big move November 23, in my MarketWatch investing column back on November 20. You can see the column here.