FSO Editorials

by Elliott H. Gue
Editor, The Energy Letter
July 6, 2006

Jesse Livermore was perhaps the most famous stock trader of the early 20th century; he made and lost millions of dollars in his day. And, for the record, that was a lot of money 100 years ago. Livermore was most famously immortalized in Edwin Lefevre�s thinly veiled biography Reminiscences of a Stock Operator, probably one of the best and most helpful books on trading and investing ever written.

One of Livermore's trading rules was �Be right and Sit Tight.�
He also said this is one of the hardest lessons for any investor to learn. In other words, Livermore suggested jumping on board a major trend and then having the courage to hold on to make the really big gains.

Clearly, energy is just such a major trend. As I've outlined on numerous occasions in The Energy Strategist, demand for oil and gas is booming while the world's ability to expand supplies and production is, at best, limited. The great commodity bull markets throughout history have lasted for at least 15 to 20 years--this current up-cycle has more than a few good years left in which to run.

But that doesn't mean there won't be corrections. Long-term readers are well aware that we've seen three significant energy corrections during the past 12 months. Each pullback lasted between one and three months and resulted in prices 15 percent to 25 percent off the highs for most stocks in the group. Each pullback also represented an excellent buying opportunity as the group subsequently rallied to new highs.

The important thing to remember is that no great bull market has been immune to such corrections. Even the Nasdaq in the 1990s and gold in the 1970s saw corrections of as much as 30 percent in the context of a longer-term trend higher.

These corrections make following Livermore's �Be Right and Sit Tight� rule so difficult. All too often, investors panic and get shaken out of the market during these corrections, thereby missing out on the even greater returns to come. At the same time, investors are correct to want to protect their gains; after all, making big money on a stock only to watch it evaporate is a sad strategy indeed.

By late April even energy bears were giving up and jumping into the sector; greed and the desire not to miss out on big gains were the prime emotions driving the market. Technical analysts (also known as chartists) term such action a "blow-off top." Normally this sort of parabolic rise and fall leads to a correction that lasts for a few months.

It seemed rather odd to be speaking of a downturn with oil near $75 and energy stocks breaking to new highs.

The fundamentals for energy stocks are outstanding right now. Every great bull market in history has seen periodic vicious corrections of as much as 30 percent before ultimately rallying to new highs. It's these ugly sell-offs that tend to shake out investors at just the wrong time; investors panic near the lows and bail out of their investments.

And it's been a long time indeed since the oil and oil services names have corrected to the extent we saw in May and June. I suspect we've seen the bottom of a cathartic sell-off that ended in a bout of panic-driven selling. The recent spike down in an otherwise long-term energy bull market offers a top-notch buying opportunity.

How To Play It

On the fundamental front, the heart of the Atlantic hurricane season is now fast approaching. To summarize, hurricane activity tends to move in multi-year cycles. Unfortunately, most meteorologists agree we're now in the midst of a more-active Atlantic hurricane cycle, meaning there's potential for a larger-than-normal number of major hurricanes to strike the Gulf of Mexico this summer.

In fact, in late May, the National Hurricane Center released its final estimates for this season, projecting a total of 13 to 16 named storms, eight to 10 of which it expects to become hurricanes. Even more important, major hurricanes (rated Category 3 or higher) cause about 80 percent of the damage from storms every year; the Hurricane Center is expecting four to six such storms. This prediction represents a significant upside departure from a long-term average of 11 named storms per season.

Gulf of Mexico oil and gas production still hasn't fully recovered from hurricanes Katrina and Rita. And supplies were severely interrupted for months after the storms last year. If another major storm were to affect drilling operations in the region, supplies of oil and gas could be cut off once again, causing another shortage and spike in energy commodity pricing.

A strong summer travel and cooling season coupled with hurricane-related supply fears are conspiring to keep a bid under natural gas and oil prices this summer. And stellar earnings coupled with the potential for further takeover activity will tempt energy stock buyers in July and August. I suspect that energy-related groups will remain above their June lows for the remainder of the summer; it's quite possible the group will retest and challenge recent highs.

Long-term, our world is mired in a perpetual energy crisis. Common energy investments will yield uncommon profits in this new Gilded Age. I would like to serve as your guide going forward, helping you to minimize risk and maximize profits in the financial markets.

Elliott H. Gue
Editor, The Energy Strategist

© 2006 Elliott H. Gue

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