ENERGY

Energy has been the place to be lately, and the returns have come from one expected sector...and one totally unexpected, writes Richard Lehmann of Forbes/ISA Closed End Fund & ETF Report.

This month’s winners were broadly in the energy sector. Three funds in the best performers list were natural gas-oriented and were funds that hold limited partnerships.

The Salient Midstream & MLP Fund (SMM) was the best performer of this group, up 11.30%, followed by Tortoise North American Energy (TYN), up 10.61%, and by Kayne Anderson Midstream/Energy (KMF), up 10.25%.

Aside from natural gas pipelines, the overall best performer was another energy play, this time solar energy. The Market Vectors Solar Energy ETF (KWT) was up 13.65%. The solar sector has been under a cloud for the last three years, due to competition from Chinese manufacturers and the decline of government subsidies.

The worst performers were a variety of volatility indexes. The indexes are all keyed to option prices, which have been at historic lows in relation to past norms. It may be that option writers, aiming to enhance yields on their portfolios, are increasing the supply of options, thus lowering the price.

The energy sector remains an interesting option in that it is a hedge against inflation. As governments print more money in order to avoid deflation, the dollar, the euro, and other currencies are falling in price.

The dollar isn’t doing so badly when compared to other currencies, but then they are all dropping as well, in relation to hard assets. Oil is a hard asset when compared to paper money and has intrinsic value that paper money does not. We could see the price of oil increase even if there is low demand and increased supply, simply because of devalued currencies.

We have previously recommended the Petroleum & Resources CEF (PEO), most recently in March 2012. It was trading at $23.42 and is now trading at $25.72. The fund was never promoted as an income-generating closed-end fund, since it paid a small quarterly dividend of 10 cents per quarter and a large end of the year payout—this year for $1.30. This policy will continue, but the fund pledges to distribute at least 6% per year.

The fund has extended a share buyback program through 2013 and aims to purchase up to 5% of the outstanding shares. It will make the buys on the open market when the fund is trading at a discount of more than 6.5%. It is currently trading at a discount of 12.40%. These market factors may serve to reduce the discount going forward.

In addition, oil prices have remained firm, and may have further upward pressure as the economy improves. The fund’s largest holdings are in the energy sector at 78%, followed by basic materials at 18%. Its largest individual holding is Exxon Mobil (XOM) at 17%.

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Tickers Mentioned: SMM, TYN, KWT, PEO

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