While the selloff in gold has dominated headlines lately, another commodity – oil – has also experienced price declines in recent months.
The main US benchmark for crude prices is down roughly 5% from a February peak. But despite this drop, here are four reasons why I’m still a fan of energy stocks.
The Outlook for Oil Prices: While the price of oil has slid in recent months, it’s starting to inch higher and is currently up significantly from its April low of $85 a barrel. Looking forward, given that expected growth in oil demand is in line with likely new production, I expect oil prices to remain in a stable range between the high $80s and the mid $90s absent a Middle East supply shock, which would arguably drive prices higher.
Cheap Valuations: Though range bound oil may not be that exciting, it may be enough to support an energy sector that has dramatically underperformed the broader market so far this month. US energy companies are now trading at a 20% discount to the broader market and at just 12.5x trailing earnings, the lowest valuation of any sector.
High Dividend Yields: The large integrated oil companies are now offering dividend yields of around 3%, likely welcome news to yield hungry investors.
A Potential Hedge Against Inflation: The energy sector, at least historically, has had a positive correlation with inflation. In other words, energy stock prices have actually gone up as inflation has risen. This means that, though I don’t expect inflation to be a worry until at least next year, energy stocks can potentially provide some purchasing power protection over the long term, albeit with more volatility than traditional inflation hedges.
In short, with oil prices likely to remain relatively stable going forward, the energy sector has become an interesting value play, especially considering energy companies’ attractive yields and correlation with inflation. One way to access the sector is through the iShares S&P Global Energy Sector Fund (IXC).
iShares S&P Global Energy Sector Fund
The author is long IXC.
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist.