The Market's Pivot Point: The Cost of Oil

The stock market is currently engaged in a tug of war between the cost of oil and everything else. Each day oil has spiked higher, the broad averages have declined, and when it weakened, they rose.

At heart, the battle is between Peak Oilists and the rest of us, who believe a slowing global economy will cool excitement in the Oil Patch by damping down demand.

I don't want to jump into this fight one way or the other. I have a smarter way to profit from energy—an exchange-traded fund (ETF) that has jumped 16% while the stock market is still struggling to recover after plummeting nearly 20% from its 2007 high, just barely skirting a full-on bear market.

But let's take a closer look at what the Peak Oilists say and why my ETF Insider pick will guide you to big profits faster than stocks but without the huge downside risk of pure oil plays.

ETFs and the Choke Point of Oil

As recently as a few weeks ago, contracts for future delivery of petroleum priced it below the spot price, suggesting traders expected a significant slackening this summer. Then last week, investors began to look beyond demand for energy to supply, and what they discovered sent oil futures' prices soaring. West Texas Intermediate, called sweet crude because of its purity, closed May 21 at $133.17 a barrel. August 2008 futures closed at $133.33. Contracts for February 2009 priced oil at $138.25.

The next day, Yardeni Research sent a memo to clients quoting an article in the Financial Times about Matthew Simmons, author of the 2006 book Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy. Said Yardeni:

He predicted that Saudi oil production was rapidly approaching its peak. According to the FT, "Less well known, but equally damning, is his study of the rest of the world's oilfields…. He found that the world depends on just a few giant, old, declining oilfields and that almost nothing to match them has been discovered since the 1970s…. Not a single field discovered in the past 30 years has ever been able to produce more than 1 million barrels per day and the number and size of fields discovered since then have been shrinking dramatically."

To put that in context: Consumption in April was 85.8 million barrels a day, a record high.

Yardeni noted that, although it's not widely known, OPEC nations themselves consume more petroleum than China, although China's consumption is increasing at a faster rate. Global consumption grew at a 1% rate (year over year) in April, down sharply from 4.6% in February, but even the lower rate was a higher percentage than growth in 2007.

This analysis leads directly to the current choke point in the energy system—exploration and production (E&P). Recent discoveries in the Gulf of Mexico and off the coast of Brazil are considered very promising, but will cost uncounted billions to bring to market. Not surprisingly, E&P has been the supercharged corner of the energy market this year. Here is a look at ETFs that target energy and its sub-sectors:

But you won't find these ETFs in my ETF Insider model portfolios right now. Even if energy is only five years into a 20-year bull market, as the Peak Oilists believe, that doesn't mean it isn't overpriced now. The higher the cost of oil goes, the more likely it is to stimulate even more significant cutbacks in usage, which itself would exert downward pressure on the price. That's why I chose a more diversified ETF for my subscribers.

A New Name for Energy

My favorite energy ETF, which I've owned for nearly four years, has risen more than 26% since I recommended it to the lucky subscribers who joined me for their first issue of ETF Insider last summer. And I remain enthusiastic about the energy theme. The price of oil is setting records in the middle of a recession in the world's biggest economy. A big part of the problem is that much of the world's supply lies under ground ruled by nincompoops.

I recently spoke to Jerry Jordan, president of Hellman, Jordan Management Co., a boutique investment manager in Boston that has a heavy commitment to the sector, about this. Here's how he put it:

"Venezuela and Mexico have problems. Iran has a problem. Venezuela kicked out all the smart folks. Mexico let its largest oil field roll over, and now they need to spend a lot more money to build it up, and they don't have it because they didn't spend it (to build it up) before."

Jordan also manages an outstanding mutual fund, Jordan Opportunity Fund (JORDX). He's got a remarkable track record despite the bear market—his fund was up an annualized 21% for the past three years as of Wednesday—and he's very bullish going forward. "The bear market is over," he says. "We believe that this was a typical cyclical bear market, as opposed to an occasional secular bear market." (My conversation with Jordan ranged over a host of topics. I'll share the full interview with you when you join ETF Insider.)

If the bear market is over, the economy won't be far behind, and global economies are stronger than ours.

Meanwhile, the ETF I recommend is a wonderful way to play energy, which accounts for 85% of its assets. But with the other 15%, it also captures the materials sector, energy's natural handmaiden. Timber and mining companies are participants in the same worldwide industrial growth as are oil and gas.

Each of my ETF Insider model portfolios has a healthy stake in this fund, and I expect it will grow in coming years as this group outperforms the broad market. Global growth has only a few natural enemies, although unfortunately they include populist politicians. If Barack Obama or Hillary Clinton really are as anti-trade as they sound, they could set this group back. So could a "windfall profits" tax.

But those would be setbacks, not the end of this bull commodity market. As the cost of oil continues to rise, I can see no end of it until nuclear power makes electricity so cheap we'll all drive electric cars. That day will come, but it won't come soon. |

Why wait for the stock market to recover when you can profit from ETFs now? Get the name of Tim's energy ETF when you sign up now for your 6-month risk-free trial subscription to ETF Insider! That's right—take 6 full months to decide if Tim Middleton's ETF Insider is right for you! If you are not fully satisfied, simply cancel your trial subscription within six months and get 100% of your subscription fee back.