Last week I showed you why oil is going down and is likely to get cut almost in half from here. Again, I believe WTI crude oil – which is trading around $45 today – will bottom out somewhere in the $20s.
That’s the situation and that’s the bad news.
Now here’s the good news. There are lots of ways to make money.
When oil prices hit the $20s, it is going to produce one of the greatest investment opportunities of the decade. Even if oil prices never come close to returning to their previous levels of over $100 per barrel, they will still rise by at least 300% during a recovery.
I feel strongly that it’s still too early to get in on the long side unless you have a very – and I mean very – long-term investment horizon. I’m talking perhaps 10 years long.
But that doesn’t mean you have to wait.
Do this to make 40% starting now…
How to Profit Later: Big-Cap Energy Stocks
First let’s look at the big-cap energy stocks.
The Energy Select Sector SPDR ETF (NYSEArca:XLE) tracks the largest energy stocks in the S&P 500.
XLE has already lost almost 40% of its value over the last 15 months, trading down from a high of $100.93 on June 29, 2014, to $63.85 at close on Friday (October 2, 2015). The companies in the XLE are big and are unlikely to go bankrupt, unlike many smaller oil companies. But with a weighted average market cap of $100.8 billion, an average price/earnings ratio of 22.7x, an average price/book ratio of 1.9x, and an average dividend of 3.16%, these stocks are still pretty expensive. And it’s going to be a long time before they’re cheap again. (I’ll let you know.)
When oil does finally hit bottom, though, they will be great investments, as will the XLE. But until then, there are options on the downside.
How to Profit Starting Now as Oil Goes Downs
I recommend targeting the sector rather than individual stocks, for two reasons. It gives you the broadest exposure. Plus, the companies that are highly leveraged have already fallen, and their dividends are a drag on a short play anyway.
I also suggest targeting the fall in the oil price rather than just natural gas. Both will go down, but oil has more downside than gas right here.
Steer Clear of the Leveraged Plays
There are many leveraged oil plays, like VelocityShares 3X Inverse Crude Oil ETN (NYSEArca:DWTI) or PowerShares DB Crude Oil 2x Short ETN (NYSEArca:DTO). I do not recommend these. They will respond 2x or 3x faster to a decline in oil, sure, but they’ll also sink faster in the event of any short-term move up. Besides, they have to reset their leverage every day, and you need to rebalance your exposure and worry more about getting the timing right.
There are two ETFs that profit from lower oil you may want to consider.
The first is the United States Short Oil ETF (NYSEArca:DNO) that tracks the daily return of futures contracts for light sweet crude oil delivered to Cushing, Okla. (WTI). As WTI drops in price, DNO rises, and DNO has doubled in price over the last year as oil has dropped by 50%. I think this is likely to continue.
The second is ProShares Short Oil & Gas ETF (NYSEArca:DDG), which provides inverse exposure to a market-cap weighted index that tracks the performance of large U.S. oil and gas companies. It is an inverse play on the Dow Jones U.S. Oil and Gas Index. DDG has appreciated by 50% over the last year as these stocks have taken it on the chin – and is likely to appreciate further as oil and gas prices remain under pressure.
If you prefer to sell short, I think the best play is to short XLE. Again, you’ll get the broadest exposure to declines in those big oil companies. (Money Morning has a great free primer on short-selling, if you’re new to it.)
A lot of investors are really uncomfortable about making money on an asset that’s going down. I get that. But you will hear me say this over and over again – denial is not an investment strategy. Oil is going lower, and people who stay long or ignore that will miss out. We on the other hand are going to make money all the way down as oil falls… and make even more when it goes back up.
Keep up with me here, and we’ll do it together.