First off, let’s be clear. I do think that we will look back on this time period as an outstanding buying opportunity in the energy sector. What exactly to buy and when exactly to buy it is a whole other question (although I have shared some thoughts on the topic here, here, here and here. That being said, I don’t know that the energy sector is poised to go “to the moon” anytime soon. There is a lot of turmoil:
*The March 2020 futures contract incredibly fell to -$37 a barrel
*The U.S. shale oil industry is in grave danger of mass bankruptcies
*Russia and Saudi Arabia have demonstrated that they are willing to create/absorb some instability in the oil market
*Will alternative energy sources become viable replacements for fossil fuels and what will that do to the overall industry
And so on and so forth. Basically, a thousand and one reasons to steer clear of the energy sector. Which of course is the number one reason to actually start looking more closely – the old adage of “buying when there is blood in the streets” does seem to be “ringing a bell”.
One Other Signpost to Consider
Figure 1 below is from this article posted on www.SeekingAlpha.com authored by Rida Morwa. I am going to be candid and say that I am not exactly sure what the red line in Figure 1 is measuring (more in a moment) – but the message appears to be pretty clear. Anyway, as I understand it, the red line in Figure 1 measures the current yield on high yield energy stocks minus….something – maybe higher grade energy stocks or a broader index of high grade corporate bonds – I found something similar at Morningstar.
Figure 1 – Energy Credit Spread vs. Oil (Source: Bloomberg and Crescat Capital LLC, courtesy www.SeekingAlpha.com)
In any event, it is hard to ignore the obvious “potential alert” that appears in Figure 1. In both 2008-2009 and 2015-2016 the credit spread soared and marked the bottom in crude oil. The red line in Figure 1 soared to an even higher new high in 2020 just as the price of crude oil cratered.
I don’t offer investment advice nor make specific recommendations. And I am not entirely convinced that crude oil and/or the broader energy sector is destined to rally significantly anytime soon. All that being said, now does have the earmarks of being a good time to stop hating the energy sector.
Ticker DBO (an ETF that tracks the price of crude oil future but DOES NOT focus entirely on the front month – which can help to mitigate the risks of contango that troubled the more actively traded ticker USO) may not do a thing. But trading under $6 bucks a share, it might look pretty good a few years from now.
Jay Kaeppel
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