Selling your oil company stocks at the bottom is a bad idea.
Many investors are reading the news intently these days, in hopes of spotting a sign that the drop in oil prices has ended and that oil company stocks will start rising again. They assume that if they get in at just the right moment, they’ll be able to take advantage of another of the violent upswings that the oil market has put on in the past, after a downturn like the one now underway.
One investor wrote to us: “When oil dropped, I waited but not long enough. I bought $50,000 of Chevron and $40,000 of Imperial. Imperial is down about $4,000 and I have a $2,000 profit on Chevron. I’m thinking about selling the Chevron and maybe wait to see if it drops more later. I have to ride out the Imperial Oil.”
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This is a bad way to invest, but especially in a volatile, worldwide market like oil and oil company stocks, and all the more so today. It’s easy to look at a long-term history of oil prices and detect what you feel is a clear, recurring pattern. However, these patterns occur in response to supply and demand in the market, and both are constantly changing.
Oil optimists assume that demand for oil will keep on growing indefinitely, as more people around the world buy cars. Oil supply can also keep on expanding indefinitely, however, thanks to technological advances that have opened up vast new oil reserves in shale deposits around the world. Environmental regulations make it difficult to tap into these deposits in some areas, of course. Meanwhile, political turmoil in the Mideast and Venezuela make future supplies of conventional oil more erratic and uncertain.
Politics, weather and market sentiment will determine whether oil users stock up on oil, or cut down on new buying while they use up existing inventory. This can have a big impact on oil-price trends and the health of oil company stocks.
What are energy stocks?
Businesses that work in the extraction, refining and delivery of energy sources such as natural gas, oil, uranium and coal, are considered energy stocks.
Resource and commodity stocks in general should make up only a limited portion of your portfolio—say less than 20% for a conservative investor or as much as 30% for an aggressive investor. And as part of that segment, energy stocks could make up, say half of that total. The rest could hold fertilizer stocks, mining stocks and so on.
Oil and gas stocks have been below-average performers lately, and many investors are tempted to get out of the industry altogether. However, the energy sector can play a crucial role in your portfolio as a hedge against inflation. The low inflation rates of the past couple of decades deserve some of the blame for the poor performance of the sector. However, energy stocks will likely rebound in years to come as the global economy rebounds.
Investors refer to buying at a time like this as “trying to catch the bottom”. Another way to think of it is “trying to catch a falling knife”. Oil has indeed come down a long way from its peak, but it could drop further. When oil company stocks hit bottom, they may turn around and shoot back up again, as it has a number of times in the past. Or they may instead go sideways for months or years.
No matter how intently you read the news on oil, you won’t gain any worthwhile advantage. You have too much competition. This market is simply too big and too widely traded for anybody to figure it out.
Instead, now is a particularly good time to stick to our three-part Successful Investor approach: Invest mainly in well-established, mainly dividend-paying stocks; spread your money out across the five main economic sectors; downplay or avoid stocks in the broker/media limelight.
Then put perhaps half the money you intend to invest in the Resources sector into oil company stocks and gas stocks. But only buy these or any stocks if you are prepared to hold them for at least the next several years.
Bonus tip: Resource stocks, though volatile, tend to rise with inflation
The resource sector, which includes oil company stocks, is subject to wide and unpredictable swings in the prices it gets for its products. In the rising phase of the business cycle, when business is booming, resource demand expands faster than resource supply, so resource prices shoot up. This balloons profits at resource companies. When the economy slumps, resource prices fall, and this drags down resource profits and stock prices.
In addition to rising and falling with the business cycle, however, resource stocks have a history of rising along with long-term inflationary trends. This gives them a rare ability: they provide a hedge against inflation.
How are the oil company stocks you’re invested in performing? Has the price of oil affected them? Share your insights with us in the comments.