Beware of Oil Company Stocks Now

My 2nd post in this blog was entitled "Invest in oil & energy." OK, I need to modify that.

Here's what I mean: Long term, oil and energy companies should continue to do well, especially the ones that are intended to provide income (like Canadian royalty trusts in general). But what I'm hearing now, from the people whose job it is to know these things, is to look for a pause and/or decline in these stock prices over the next few weeks and months.

But "What?" you say ... "We're just now approaching the height of hurricane season." Yes, and when did the highest oil prices, and oil stock prices, occur last year? Look at a chart of XLE, the oil company ETF (exchange-traded fund). Most of the increase came before Katrina. After Katrina hit on August 29, prices rose (relatively) slowly for the next month, finally reaching about 8% higher at the end of September. Then they suddenly plunged nearly 20% in three weeks. It was not until January 2007 that the Katrina peak was exceeded.

In fact, at this writing, XLE's latest close was at 54.48 on July 21, below the Katrina peak of 54.65.

So higher oil company stock prices are not a given. In fact, there are several signs that the XLE is heading into a multi-month decline. If the stock market as a whole declines over the next few weeks, as the odds seem to say, then oil stocks could easily go along for the ride. Oil stocks are, after all, stocks.

Another way of looking at this: In the short term, stock prices are influenced primarily by trader psychology, not fundamental factors such as profits and news events. Everyone has been buying oil stocks in anticipation they will go up. When everyone that wants to buy has done so, then prices have no place to go but down.

Hedge funds especially have been a big influence on the markets over the last few years. They all buy things that go up. When those things start going down, all the hedge funds have to sell at once, and the door is too small for everyone to get out in time.

So right now is probably not the time to jump into oil stocks. In fact, you might want to:

1. Sell some.
2. Donate stock instead of selling it. This is one of the best tax breaks you will find.
3. If you are a trader, you can sell short the XLE, and/or the OIH (oil services ETF) and hold that position for a few weeks or months.
4. If you are an options trader, you can buy put options on XLE and/or OIH.

Numbers 2 through 4 are good if taxes are a concern (and for most of us they are, unless your holdings are in an IRA).

If you don't want to be a trader, just be prepared for oil stock pain. Make sure your portfolio is tilted toward income. If you want to get started buying for the longer term, don't jump in all at once -- either feed money in on a regular monthly basis, or buy some more every time there are a few days of decline.

When I start hearing the message that oil stocks are making a bottom, I'll post it here. I pay a lot of attention to energy investing, as you may have guessed. I own a lot of these stocks, but recently for protection I've been doing all four things listed above. (Again, the best way is not all at once, but gradually.)