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We're in that last momentum stage now. In the first part of 2008, when oil was climbing toward $90 a barrel on the New York futures market, you could hear dissenting voices loud and clear: The price isn't justified by the fundamentals. It won't stick. It's driven by speculation. Oil stocks are overpriced. Don't buy them. They're at a top.
As oil prices climbed toward $135 a barrel, those voices gradually changed their tune. In recent weeks, I've heard members of the Federal Reserve say that recent oil prices are reasonable given the deteriorating fundamentals of the oil industry. The International Energy Agency has gradually cut its predictions for world oil supply and then launched a study that seems designed to show just how bad things "really" are.
Wall Street analysts have begun competing to see how high they can ratchet their projections for oil prices -- $200 a barrel, says Goldman Sachs -- and the higher projections have increasingly found their way into target prices for oil stocks.
I've been a believer in higher oil prices and higher prices for oil stocks for a long time. I was too early in Jubak's Picks with Forest Oil (FST, news, msgs) in 2003 and Chevron (CVX, news, msgs) and BP (BP, news, msgs) in 2004. And then profitably in time with XTO Energy (XTO, news, msgs) and Talisman Energy (TLM, news, msgs) in 2005, and Marathon Oil (MRO, news, msgs) and Devon Energy (DVN, news, msgs) in 2006. (Although I do wish I'd held on to many of these longer.) Not so long ago, I called for $180-a-barrel oil within two years.
It's gratifying to see the market increasingly share my view. But it's worrying, too. When everyone agrees that oil stocks are the thing to own, where is the supply of new buyers going to come from? And without new buyers, oil stock prices will stagnate and then fall.
Fortunately, not everyone is convinced yet. Oppenheimer oil analyst Fadel Gheit, for example, continues to write that, fundamentally, oil shouldn't trade at more than $55 a barrel. To which I say, God bless. The minute the last skeptic turns into a believer and bellies up to buy oil shares, the rally in oil stocks is doomed.
Still, I'm worried there aren't enough skeptics left. Oil stocks have looked increasingly frothy this year. One sign of that is the huge gains being racked up by obscure small-cap stocks in the sector. These are exactly the kinds of stocks that attract the extreme momentum traders as a sector nears a top.
This year, through May 27, Trans Energy (TENG, news, msgs), with a market capitalization of just $13 million, is up 52%; Rex Energy (REXX, news, msgs), with a market cap of $37 million, is up 98%; and Mariner Energy (ME, news, msgs), with a market cap of $88 million, is up 51%.
Here's some advice
So what does all this mean to you? Five things:- If you haven't bought oil stocks yet, I'd wait for a correction rather than chase them here.
- If you own oil stocks, you might want to take some profits in the sector. There's no need to sell everything, but check to see whether your portfolio is out of balance, and trim back your exposure to the sector.
- If you need to add energy stocks to your portfolio, take a look outside oil. Natural-gas stocks, for example, haven't had nearly the run that oil stocks have, and natural gas is still well below its historic peak of $15 per million British thermal units. If you need a suggestion or two in the sector, check out Chesapeake Energy (CHK, news, msgs) and Ultra Petroleum (UPL, news, msgs) in Jubak's Picks. Devon Energy, in that portfolio, is a big natural-gas producer, although not a pure play like Chesapeake and Ultra.
- Remember that the key to making money in the stock market is to buy low and sell higher. It's time to start looking around for unloved stocks in other sectors.
- We're by no means near the end of higher oil prices or of higher prices for oil stocks. Just wait. If oil drops to $110 -- the new floor, in my opinion -- you'll hear a huge chorus of doom saying that $50 a barrel is just around the corner.
That, of course, will be the time to buy.
Continued: Developments on past columns
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