Comeback Candidates: Oil and Gold

03/02/2018 5:00 am EST

Focus: COMMODITIES

Kuen (Scott) Chan

Editor, Investing Daily's Real World Investing

Comebacks are always in style; here we highlight five stocks that struggled last year but are likely to rebound strongly as their industries pick up steam, explains Scott Chan, editor of The Complete Investor.

Oil service companies in particular have lagged. They depend on the explorers and producers to hire them. And the explorers and producers, which cut back sharply on operations as oil prices dropped, still seem gun shy about committing to new drilling projects.

But that should change as it becomes increasingly clear that higher oil prices won’t retreat. Signs include falling U.S. crude inventories, OPEC’s decision to continue to limit output, and geopolitical tensions in the Middle East.

Once producers’ sentiment reaches an inflection point, producers could rush to invest in growth for fear of missing out on the next up cycle. Demand for oil services could surge.

That makes Schlumberger (SLB), the global leader in oilfield services, a good bet as a comeback stock. It has worked hard to develop products that allow oilfields and wells to operate more efficiently.

Helix Energy Solutions Group (HLX) is a far smaller services company that focuses on the offshore drilling and exploration market. Schlumberger is one of Helix’s main clients.

Because it is not a contracted offshore driller, it avoids the huge costs of maintaining a rig fleet. Its well-intervention services and undersea robots help deep-water operators improve safety and cut costs.

The offshore oil sector remains weak, and while the worst may be over, recovery may still be a few quarters away. Helix, although a quality company, is a more speculative bet than Schlumberger.

But its smaller revenue base means a relatively small improvement in business could bump growth into double digits. The longer oil prices remain elevated, the more likely that will happen as demand rises for the company’s services.

Core Laboratories (CLB) provides technologically advanced services to the oil and gas industry — for example, analyzing and characterizing oil and gas properties — to optimize efficiency and returns. It, too, should rebound as the energy sector improves.

Our two other comeback candidates are both gold stocks. In 2017, gold rallied from below $1,150 an ounce in January to above $1,300 by yearend in a somewhat jagged uptrend. Most gold stocks, though, were down.

For several reasons, we expect gold prices to continue to strengthen, possibly by a lot. The rise in oil and other commodities will spill over into gold, which typically rallies whenever commodities markets are strong.

Meanwhile, a slowdown in gold exploration during the years of depressed gold prices suggests global production will be flat or will even decline.

Even if gold just made a push toward $1,400, it would provide a welcome boost to both Barrick Gold (ABX) and NovaGold (NG). The two companies share a 50:50 stake in the potential world-class Donlin Gold project, where the permitting process has reached the final stages. The two companies could receive full permits by the year’s second half.

NovaGold’s share price suffered an extra blow from investor concern that to raise money to develop Donlin, the company might need to sell additional equity, diluting the shares.

But NovaGold, which currently has no debt, could borrow instead or sell some of its ownership in Donlin. And higher gold prices would make the economics of Donlin even more appealing, giving NovaGold more options to raise money on favorable terms.

We fully expect NovaGold will find investors willing to finance development of Donlin – possibly entities with Chinese ties. Barrick’s CEO John Thornton has deep roots in China. Both Barrick and NovaGold are good bounce-back candidates.

For investors more comfortable with betting on the industry rather than on individual stocks, VanEck Vectors Oil Services ETF (OIH) and Growth Portfolio’s SPDR Gold Shares (GLD), a gold ETF, are our picks for one-stop investing.

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