Oil Stocks: Are You Ready For A Rally?

| April 27, 2012 | 0 Comments

No doubt about it, the S&P 500 is having a great run.  Even if you factor in the recent correction, the widely watched index is up a hefty 11.4% since the start of the year.

That’s an incredible four-month rally no matter how you slice it…

But as impressive as 2012’s broad market performance has been, there’s one industry that’s been lagging behind… oil exploration and production (E&P).

In fact, the iShares Dow Jones U.S. Oil & Gas E&P Index ETF (IEO) is up a mere 2% since the start of the year.  This ETF holds industry leading oil companies including Occidental Petroleum (OXY), Anadarko Petroleum (APC), Apache (APA), and more.

What’s even more interesting is these stocks have fallen behind while the price of oil is near multi-year highs.

Take a look…

As you can see, there’s a big disparity between oil prices and E&P stocks (blue circle) right now.  In early April, oil stocks started heading south while the price of crude remained well over $100 per barrel.

What’s going on?

Part of the reason why oil stocks have underperformed is that investors don’t believe crude will remain at such high levels.  After all, one of the main reasons crude shot to $110 a barrel in the first place is the standoff with Iran.  Saber rattling over the country’s nuclear program sent crude surging in February.

But now that the standoff with the rogue country appears to be easing, reasons for oil to stay above $100 are running slim.  In fact, US crude supply/demand fundamentals are starting to look slightly bearish.

Recent Energy Information Administration (EIA) inventory reports reveal US crude supplies are growing at a staggering pace.  If inventories are rising, prices should start coming down.

Unless Iran returns to their hard line stance with their nuclear ambitions, oil prices could drop below $100 in the near future.

So does that mean oil and gas stocks are about to dive even further?

Not so fast…

The stocks I mentioned earlier have already become drastically oversold and undervalued in recent weeks.  In fact, APA is currently trading at a mere 6.7x forward earnings estimate.  That’s cheap.  The S&P 500 index trades at a much higher 13.5x earnings.

What’s more, take a look at this week’s relative performance for IEO and you’ll find something interesting…

E&P companies are rallying in lockstep with the S&P 500.  It looks like investors are finally realizing the value and upside potential in E&P stocks.  Not only are OXY, APA, and APC heading higher, but a slew of industry leading companies are on the move.

Will the rally last?

Even if crude prices weaken a bit in coming months, I believe oil stocks are near their low point for the year.  Barring some unforeseen market shock, E&P stocks will likely be much higher by the end of 2012.

Now don’t get me wrong, we’ll likely see plenty of volatility in coming months.  The markets are entering a weak time of year.  So, further gains may not come easy.

But rest assured, oil stocks hold some of the best upside potential the market has to offer right now.

How can you capitalize on this opportunity?

The easiest way is to buy the ETF I mentioned earlier… the iShares Dow Jones U.S. Oil & Gas E&P Index (IEO).  IEO is highly liquid and trades just like a stock.  But more importantly, it holds some of the world’s leading oil companies.

If you’re looking for value in the markets, E&P stocks should be at the top of your list!

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Category: Commodities

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.

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