Fear Stokes Oil’s Strength

12/10/2007 12:00 am EST


Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann, editor of the ISA ETF Investor, says high crude prices made oil ETFs top performers last month, and he looks for oil service stocks to continue their run.

The single unifying theme for [last] month's market performance [was] the predominance of fear.

There seem to be two schools of fear-one of a recession, the other of inflation. Those that are worried about a recession buy Treasuries hoping to ride out the downturn and have their money safe and still earning a return. Those who worry about inflation buy precious metals and energy, hoping that both will increase with inflation.

The risk takers seem more concerned with inflation and are buying hard assets; thus, gold and oil are increasing (although both have sold off recently-Editor). The value of the dollar is another wild card, which seems to go along with the risk-taking crowd that wants hard assets.

The big [domestic] winners last month were oil-related funds. The best performer was one of our most recommended funds, the US Oil Fund LP (AMEX: USO), which was up 9.91% for the month. With the exception of three silver funds, the rest of the top performers were all oil-related. Oil prices as measured by the iPath S&P Goldman Sachs Commodity Index (GSCI) Crude Oil Total Return Index ETN (AMEX: OIL) are up 44.07% for the year.

In recent earning reports, oil companies are complaining about the increased expenses of exploration and development equipment. With oil prices [near $90], the demand for such equipment is high. In fact, if oil prices drop the demand will remain.

The supply/demand balance has shifted out of balance, with demand outpacing supply. The Organization of Petroleum Exporting Countries (OPEC) has lost the ability to control prices because demand outpaced their production capacity. Nevertheless, OPEC does attempt to keep prices higher then their previously announced targets by cuts in production. New oil exploration and production is essential just to keep up with demand.

We think the demand for oil will continue-and with it, the need for more exploration and production equipment. The increasing demand for such equipment will keep the oil service providers in high margins and brisk business. The Oil Services Holders Trust (AMEX: OIH) focuses precisely on these industries. We first recommended the fund back in June 2005 at $101.50 and most recently in May 2007 at $154.08. The trust closed Friday [around $184.50]. (Its holdings include oil service giants like Schlumberger, Baker Hughes International, and Transocean-Editor.)

As market indicators go, I find that when you get client calls where they are seriously considering selling everything, you are near the bottom. This is because when things look the worst is when the pros start buying. Of course, you won't know this until after the fact, but this is why investment is a discipline and not a sporting event. Technical factors argue for the market to turn around in late December and for January to be quite positive.

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