Published January 25, 2016

What We’d Like to See Before Buying Oil Stocks

Is it time to buy beaten down energy stocks?

Energy prices have collapsed over the past 19 months. Last week, oil closed below $27 for the first time since 2007. Oil is now down 70% since June 2014.

The price of natural gas has dropped 53% over the same period. Last month it hit $1.74, its lowest price since 1999.

Shares of giant U.S. energy companies have crashed...

Since June 2014, Exxon Mobil (XOM), the largest U.S. oil company, has fallen 25%. Chesapeake Energy (CHK), the largest U.S. natural gas company, has plummeted 89%.

Halliburton (HAL), the largest U.S. oil services company, has plunged 56% since June 2014. Oil services companies sell “picks and shovels” to the oil industry.

•  Kinder Morgan’s (KMI) stock has tanked…

Kinder Morgan is the largest U.S. pipeline company. It operates 84,000 miles of oil and natural gas pipelines. Companies pay Kinder to transport oil and gas through its pipelines.

In the early stages of the energy collapse, brokers sold Kinder stock as a less-risky way to invest in energy. Investors looking for safe income piled in. In 2014, Kinder Morgan paid a 4.8% annual dividend yield...2.5 times higher than the S&P 500’s dividend yield of 1.92%.

Big energy companies’ profits depend on oil and gas prices. But as a “toll road” that makes money based on the volume of oil and gas it moves, Kinder should be able to withstand low oil and gas prices. At least that was the theory…

In reality, crashing oil & gas prices have slammed Kinder’s business. Last year, the company’s first-quarter sales dropped 11% from the year before…second-quarter sales dropped 12%...and third-quarter sales dropped 14%.

Last Wednesday, Kinder Morgan’s stock hit an all-time low of $12.01. That’s a 73% decline in less than two years.

•  After Wednesday’s close, Kinder Morgan reported an 8% drop in fourth-quarter sales...

The company lost $0.29 per share. It was the worst quarterly loss in the company’s history.

•  Many investors were caught off-guard when Kinder Morgan’s stock tanked…

Market Watch reported last month:

Pipeline and fuel storage companies have been prized by many investors as the safest way to invest in the U.S. shale boom. But the companies paid out most of their available cash to shareholders eager for reliable dividends, which left many of them with large debt loads and at the mercy of lenders' and investors' willingness to continue lending to fund new projects.

Until recently, borrowing or raising more money hasn't been a problem. The fees that pipeline companies charge brought in steady, toll road-like revenue, and the companies were much loved by yield-hungry buyers, often wealthy retirees, who wanted steady dividends with little risk. Now that oil and gas prices have plummeted to less than half their 2014 peak, lenders could be tightening their requirements to tap more capital.

•  On its earnings call, Kinder Morgan announced major spending cuts…

The company slashed this year’s capital spending budget from $4.2 billion to $3.3 billion. Last month, the company cut its quarterly dividend by 75%. It was the first time in company history that Kinder cut its dividend.

As Casey readers know, Kinder Morgan is one of many major energy companies to cut spending recently. According to banking giant Barclays, global energy producers cut spending by 23% last year and plan to cut another 15% this year.

•  Investors were happy with Kinder’s cost-cutting plan...

Kinder Morgan’s stock jumped 15.6% on Thursday. It was the stock’s best day ever. And it climbed another 11% on Friday.

The rally has many investors calling a bottom in Kinder stock. Barron’s published a story over the weekend titled “Kinder Morgan Hits Bottom”…

We think these calls are premature. The chart below shows the performance of Kinder Morgan’s stock since the start of 2014. You can barely see the recent spike in Kinder’s stock price…

•  The energy market is highly cyclical…

It goes through huge booms and busts. Today, the energy market is in a major bust.

As Casey readers know, large oil and natural gas deposits (and the companies that own oil & gas infrastructure) are some of the most valuable assets on the planet. Owning these top resource companies can make you rich…if you buy at the right price. Buying top resource companies at bargain prices is a key strategy we use to build lasting wealth.

•  But we’re not buying Kinder Morgan stock yet…

Kinder Morgan stock is still plummeting. And it’s extremely risky to buy a stock that’s plummeting.

Instead, we like to buy stocks that have “carved out a bottom.”

“Carving out a bottom” is a simple concept. A stock in a downtrend carves out a bottom when it stops falling, forms a bottom for a period of time…and then starts climbing higher. A stock that’s carving out a bottom should hold above a certain price for a significant amount of time. This is a key signal that buyers are stepping in at this price, giving the stock a floor.

The chart below shows video streaming giant Netflix (NFLX) carving out a bottom. It traded in a range for 17 months before finally breaking out in January 2013. The stock went on to gain 257% over the next 11 months.

We’ll let you know when oil and gas stocks start to carve out a bottom.

Chart of the Day

Are gold miners carving out a bottom?

Today’s chart shows the performance of the Market Vectors Gold Miners ETF (GDX), which tracks the performance of major gold mining stocks.

Gold miners are leveraged to the price of gold. When the price of gold jumps, shares of major gold miners can jump two or three times more.

GDX has been in a downtrend since gold peaked in 2011. In the summer of 2015, it started to carve out a bottom. As you can see, the price held above $13 for about six months.

However, GDX recently broke below $13 and hit a new low. Although it didn’t drop much below $13, this is a reason to invest with caution. It’s a possible sign that the carved bottom won’t hold.

We’re optimistic on gold miners. GDX has fallen 80% since 2011, making gold stocks extremely cheap. When gold stocks rally, the gains could be huge.

However, we’re taking a cautious stance for now while we wait to see if this recent bottom holds.

Regards,

Justin Spittler
Delray Beach, Florida
January 25, 2016

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