The Endless Rise of Energy Stocks

Same story, different year. That about sums up energy and industrial-material stocks so far this year. The two sectors continue to lead the SP 500 -- both up about 10% through the first quarter.

How long does this go on? Charles Ober, manager of T. Rowe Price New Era fund (symbol PRNEX), which specializes in these types of stocks, thinks the bull market in energy and materials still has two or three years to go. "It takes a long time to get new oil wells and mines into production," he says. "It takes seven years to bring on a deep offshore oil field."

But he's turned a little more cautious than he has been the past couple of years. Ober is my favorite in this sector, partly because he predicted the current energy bull market -- not long before it began. For a more aggressive but equally good fund, consider Andy Pilara's RS Global Natural Resources (RSNRX).

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Personally, I like Ober's conservative approach. In a volatile sector, where vicious plunges usually follow sharp rallies like the one we're experiencing now, I feel more comfortable with a manager who worries a lot about downside risk.

New Era has returned an annualized 17% and 14% over the past five and ten years, respectively, putting it in the top 40% over both periods among sector funds specializing in energy stocks. But most rival funds are far more volatile and often invest only in energy stocks. By contrast, New Era has about 60% of assets in energy, with the lion's share of the remainder in industry materials.

The case for energy and materials

Ober's bullish case is a simple one of supply and demand. This is a story everyone has heard: With increasing demand for energy and raw materials, particularly from China, suppliers of these commodities remain in the catbird's seat until supply inevitably catches up with demand.

But things have gotten a little murkier, Ober says, particularly since the situation with Iran has heated up. Iran has threatened to cut oil production unless other countries stop trying to dictate its nuclear plans. "Geopolitics is holding up the price of oil, which otherwise would fall," he says.

Energy inventories are much higher than they were a year ago, yet the price of oil still heads higher. In addition to political worries, Ober is concerned about all the hot money chasing these stocks. "Everybody chases returns," he says. This is a momentum game, and momentum players can turn on a dime.

These factors will almost certainly cause the prices of energy and materials stocks to bounce around in the short term. Over the next three or four years, however, Ober is reasonably confident that oil will settle at around $40 to $45 a barrel. Such a decline in price will hurt energy stocks along the way, but the companies will remain profitable at those levels. "The stocks will suffer some pain," he says, "but these companies can do very well at those prices -- particularly the energy-services companies."

Ober's favorite names

Despite the huge run-up in stock prices -- energy stocks are up an annualized 37%, on average, the past three years -- price-earnings ratios remain low. That's because many analysts believe the peak in earnings will come next year and that earnings will tumble from there. "I think they're wrong on both counts," Ober says.

Given his confidence in energy-services stocks, it's not surprising that Schlumberger (SLB), the world's largest and most diversified energy services firm, is one of his favorite stocks. Yes, everyone likes it. But investors like it for a reason: It's wonderfully managed. The firm has built ties with governments in the world's hot spots, which so often hold the largest supplies of oil and gas. "This is a stock you can put away for two or three years and do well with," he says.

Total (TOT), the French energy giant and the world's fifth largest oil and gas company, is another Ober pick. "Management is top notch," he says. "And they will make money when oil and gas fall to lower prices."

Finally, he recommends Australian mining firm BHP Billiton (BHP). The firm is selling all kinds of raw materials, especially iron ore and copper, to China. It has a geographical advantage over many competitors.

For my money, though, you'll do better with Ober's fund. Don't overdo it, though. You wouldn't want to put more than 5% to 10% of your money in this fund. Commodities are called "cyclicals" for a reason. And the cycles always end.

Opinions expressed in this column are those of the author.