Here are some tips on successfully investing in commodity stocks
There are four primary categories of commodities currently traded on the market: Energy (gasoline, oil, etc.) Metals (gold, silver, platinum and copper) Livestock (pigs, cows, etc.) and Agricultural (corn, cocoa, coffee, cotton, etc.)
Note that 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, perhaps half of that total.
6 tips for investing in commodity investments in the energy industry.
- Look for oil and gas exploration companies that have cash flow from existing wells that is sufficient for, or at least contributes to, the development costs of additional wells.
- Look at the market cap of oil and gas exploration companies versus the estimated value of the reserves they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of their findings. We like an oil and gas exploration company’s market cap to be no more than half the value of the oil and gas in the ground.
- Invest in oil and gas energy stocks that use innovative new drilling and exploration techniques. Staying ahead of the curve will keep them in business.
- Invest in oil and gas energy stocks that own diversified drilling sites in multiple geographic locations where exploration has been successful in the past.
- Junior energy stocks are risky to invest in, because it’s relatively cheap and easy to launch a penny oil or other energy stock and sell stock to the public. So the junior energy promotion business attracts more than its share of unscrupulous operators and stock promoters.
- Stay away from junior energy stocks operating in insecure and politically unstable regions like Nigeria and Kurdistan, or in countries with little respect for property rights and the rule of law, like Russia or Venezuela. Resource extraction is inherently a politically vulnerable business; you can’t move the oil wells to another country, and local citizens sometimes believe that a foreign resource company is robbing them of their birthright, even though they need the foreign company’s capital and expertise to get any value out of the ground.
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5 tips for selecting the best energy stocks for long-term investment gains.
- Look for well-financed companies with no immediate need to sell shares at low prices. These stocks typically have strong balance sheets with low debt. If they’re junior mines, we like to see a major partner who can finance the mine to production.
- Avoid “over-the-counter” trading. Regulatory reporting is lax in over-the-counter trading.
- Avoid unsustainably high prices. Unsustainably high trading prices in relation to a company’s assets are often a result of broker hype or investor mania.
- Find experienced management teams. We seek an experienced management team with a proven ability to develop energy. We make sure they’re not in any insecure or politically unstable regions such as the Congo and Venezuela, or in countries with little respect for property rights and the rule of law such as Russia or Mongolia.
- Look at the market cap and the estimated value of the energy resource. We look at the market cap of energy mining stocks versus the estimated value of the energy resource they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of its reserves. We like an energy stock’s market cap to be no more than half the value of those reserves. We assume that the company will be able to expand its reserves with more exploration, but if the current reserves are double the energy stock’s market cap, it provides a margin of safety.
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List of energy stocks that will boost your resource stock gains
Our energy investing tips and list of energy stocks will help you better spread your money out among top energy shares
The best energy stocks for long-term investment gains have some things in common.
First, these stocks typically have strong balance sheets with low debt. If they’re junior producers, we like to see a company with the funds to finance their reserves to production. These stocks are also from companies with experienced management teams. We look for an experienced management team with a proven ability to use the latest technologies.
The best of these stocks don’t trade “over-the-counter” trading because regulatory reporting is lax in OTC trading.
Next, avoid unsustainably high prices when buying energy stocks. These prices are often a result of broker hype or investor mania.
Finally, we look at the market cap of energy stocks (and mining stocks as well) versus the estimated value of the resources they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of its reserves. We like an energy stock’s market cap to be no more than half the value of those reserves. We assume that the company will be able to expand its reserves with more exploration, but if the current reserves are double the energy stock’s market cap, it provides a margin of safety.
Our list of energy stocks
- Cenovus Energy Inc. (Toronto symbol CVE) owns Western Canadian oil sands properties and conventional oil and gas wells. Cenovus is a buy.
- Chevron Corp. (New York symbol CVX) is the second-largest integrated oil company in the U.S. by revenue, after ExxonMobil. Chevron is a buy.
- Imperial Oil Ltd. (Toronto symbol IMO) is Canada’s second-largest publicly traded oil company, after Suncor Energy. Imperial is a buy.
Investing in precious metals (and copper): What you need to know
While sometimes risky, investing in precious metals can lead to strong performers when commodity prices move up.
Convenient ways to invest in gold and silver mining stocks:
If you want to invest in gold and silver, we think the best way to do it is through gold and silver mining stocks or ETFs. We recommend staying away from silver or gold bullion, certificates representing an interest in bullion, and other silver and gold bullion alternatives, such as so-called “junk silver” coins (these are common coins with no numismatic value that trade strictly on their silver content).
Stick with shares of gold-mining firms when investing in gold:
We feel that investing on the basis of price changes for gold in the form of bullion, instead of in shares of gold companies, is more of a gamble than an investment. These activities don’t earn income, but instead consume funds for storage fees, insurance and so on.
A better way to profit from rising gold is by investing in the stocks of gold-mining companies. That way, you benefit from increases in the price of gold, and you give yourself the potential for capital gains and income. You also save on the higher brokerage fees and commissions associated with other types of commodity investments.
Many industrial uses of copper can give copper stocks an advantage over gold and other precious metal stocks:
Traditionally, investors have bought copper stocks as a way to profit from general economic growth. Copper has a wide range of industrial uses (unlike gold and silver, which are thought of more as hedges against inflation). Copper is heavily used in the power-transmission and construction industries, in cables, wires and plumbing.
Stocks of firms that produce base metals, including copper, generally have higher dividend yields than gold stocks. As well, they’re usually much cheaper than gold stocks in relation to their earnings and cash flow. That means they potentially have less room to fall if markets fall. That’s just another way of saying they can be considered somewhat less risky than gold.
Copper should benefit not just from rising demand, but also from tightening supply. In the short term, labour problems and technical delays will continue to slow global copper production.
Over the longer term, ore grades are also falling at many major mines around the world as producers use up the easy-to-mine ore zones in their copper deposits. Environmental issues are also making it harder for companies to acquire permits for new mines.
7 guidelines to buying gold stocks as an investment
- To increase your gold returns, look for well-financed companies with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests.
- High-quality gold stocks should have strong balance sheets with low debt. Junior mines should have a major partner who can finance a mine to production.
- Another key ingredient is an experienced management team with a proven ability to develop and finance a mine.
- We think you should avoid stocks that trade “over the counter,” where such things as regulatory reporting are lax.
- We also recommend avoiding stocks that are trading at unsustainably high prices as a result of broker hype or investor mania.
- Compare the market caps of the stocks with the estimated value of their assets or future earnings streams. Some need to quickly find a mineral deposit and begin production to justify the current share price and avoid collapse.
- Above all, you should automatically rule out investing in companies that promote themselves too aggressively, or do so misleadingly. Success is more likely if the managers focus on finding or developing a mine, rather than touting their stock.
Follow our three-part Successful Investor strategy
- Invest mainly in well-established companies;
- Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; Utilities);
- Downplay or avoid stocks in the broker/media limelight.
Have you invested in commodity investments? Have they been profitable for you? Share your experience with us in the comments.