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A correction in oil prices gives you a shot at getting long-term energy holdings.
Oil is a curious beast. It has cycled up and down for decades, but over the past few years, it’s been in a pretty solid trading range. Strangely, however, oil prices have been breaking down. It doesn’t seem to correlate the stock market’s recent correction, nor would we expect it to. Instead, it is likely due to the never-ending drama of the Middle East oil barons.
So that means you should take advantage.
Oil prices have fallen about 20%, and oil stocks along with it. I view energy as a core holding of any long-term portfolio. The world will always need fossil fuels. The world fights wars over oil. All the wind and solar in the US make up 1% of energy production, even after all the blathering of alternative energy advocates.
You’d be crazy not be invested in energy in some way. The question is what exactly is the best way. I have three suggestions.
First, consider a broad oil exploration and production ETF. I like ETFs because they are diversified. Yes, they fall in concert and rise in conjunction with oil prices, but they give you protection in the event one or two big companies get into trouble. If you were only holding those stocks, you might have a problem.
Thus, the Energy Select Sector SPDR ETF (NYSE:XLE) is a good basic place to start. It has all the biggest brand names in energy, the top ten of which make up 61% of the ETF. Even with the recent 14% decline, it still has a 17.86% 3-year total return.
If you want broader exposure, consider the SPDR S&P Oil and Gas Exploration and Production ETF (NYSE:XOP). This ETF includes a lot of smaller companies that aren’t the world-class brand names. It is vastly more diversified, and the top ten holdings only make up 13% of the ETF. It has a slightly higher 3 year return at 18.3%, but that includes the fact that it is off 28% from its highs.
If you want to extend out a bit, think about the oil services sector. The iShares Dow Jones US Oil Equipment and Services Index Fund ETF (NYSE:IEZ) also skews to the larger well-known oil service names. Again, you have a fairly concentrated basket, with the top ten holdings representing 65% of the ETF. You’ve got some risk here, too, with 3 year total return at 16.16% after a 24% decline off its highs.
You can also choose to tie you investment in energy directly to the price of oil with the iPath S&P GSCI Crude Oil ETN (NYSE:OIL), which ties you to the price of West Texas Intermediate Crude, using futures contracts. This is not for those who aren’t totally speculative investors.
The most conservative choice? Frankly, I’d go with one of the great energy companies like ExxonMobil (NYSE:XOM) or Chevron (NYSE:CVX), perhaps in conjunction with the XLE. These companies are enormous. They generate tens of billions in operating cash flow, and billions in free cash flow. They’ve gone up over time, and will never struggle. They pay dividends. You’ll sleep well at night.
Lawrence Meyers does not own shares of any security mentioned.
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