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Let high gas prices fill your portfolio's tank
Oil and gas prices are hitting new records, and other commodities are following right behind. Here are 6 ways to play those sectors.
By Timothy Middleton
With the cost of gasoline topping $2 a gallon and seemingly headed to $3, the only people smiling are the ones who own the gasoline.
These days, that group includes a small but increasing number of mutual-fund investors. Energy funds have become the new technology funds. They're pulling in assets and leading all other sectors in returns over three months, a year and three years, according to Morningstar.
Last year, for instance, Vanguard Energy Fund (VGENX) shot up 36.7%, its second 30%-plus year in a row, and its assets more than doubled to $4.71 billion. Not three months into this year, it's up a further 15%.
And there's no end in sight. Morgan Stanley last month boosted its estimate of average crude oil prices this year and next by 16%. The firm's report to clients said, "Our earnings estimates have increased by 15% for 2005 (and) 10% for 2006. . . . The consensus earnings estimates are at least 10% too low for 2005 and 15% too low for 2006."
Petroleum isn't the only commodity demanding a higher price: Natural gas, industrial and precious metals, lumber and other commodities are all at generational highs.
I last highlighted this trend nearly a year ago in a column headlined "Here's a bubble you can still buy." In it, I predicted the upward move had legs, and could last "at least a couple of years."
So far it has. In that column I cited T. Rowe Price New Era (PRNEX) as a conservative way to play the energy and commodity group. In the 12 months ended March 16, that fund was ahead 38.6%, with nearly a quarter of those gains coming this year.
Fuel for a rally
There's plenty of reason to believe the rally will continue, and plenty of believers betting that way. J. Robert Collins, former president of the New York Mercantile Exchange, in December launched a hedge fund, MotherRock LP, that invests strictly in energy. He predicts oil will trade in a band of $45 to $55 a barrel for at least three years, and may hit $60.
Researchers at Leuthold Group, a research division of Weeden & Co. that specializes in sector rotation, this month identified 10 industries most likely to appreciate in coming months. Seven of them are commodities, from oil and natural gas to agricultural products.
Increasing demand for resources in the global economy, pushed by GDP growth of 6.6% in India and 9.5% in China, is one big reason for the commodity price hikes. Refineries are having trouble keeping up with rising demand, and OPEC complains -- through crocodile tears -- it has lost control of the market.
Last month the London Metal Exchange Index spurted 5.2% as copper, aluminum and zinc hit their highest price levels in the current economic cycle.
Black gold, or the real thing?
Fund investors face two main choices: Whether to invest strictly in energy, or to broaden their reach to include metals and other resources.
Related news and commentary on MSN Money
Most funds investing in this group stress energy, and of these, Vanguard Energy dwarfs its rivals. The next-closest is Fidelity Select Energy (FSENX), with one-quarter the assets.
Due to its surge in popularity, Vanguard closed the fund for what it called a "cooling-off period" in December, but it remains open in 401(k) plans that offer it.
Morningstar analyst Sonya Morris says "prudence is a watchword" at Vanguard Energy, which is sub-advised by Wellington Management. Manager Karl Bandtel has the fund concentrated in the biggest diversified oil giants, such as Exxon Mobil (XOM, news, msgs) and Total S.A. (TOT, news, msgs).
Vanguard Energy Vipers (VDE) is a quite different portfolio. It is not actively managed but rather is indexed to the MSCI US Investable Market Energy Index. Launched only last September, it is ahead a sparkling 17.1% this year, easily beating its more-famous sibling.
The MSCI energy index is weighted 52% in integrated oil and gas producers, refiners and distributors, with the balance in specialized segments of the oil patch, from drilling to transportation.
New Era, old fund, good prospects
Among resources funds, the original is still the biggest and one of the best. Launched in 1969, T. Rowe Price New Era has had only two managers: T. Rowe Price Chairman and President George Roche until 1997, and Charles Ober since. The fund has had only two losing years in the last 10, each a single-digit retreat, and seven years of double-digit gains, including last year's 30.1% advance.
As for the portfolio's most recent report, Ober (who was traveling in Asia last week and couldn't be reached) had only 56% of the fund's assets in energy. He typically diversifies his fund very broadly among mining, paper and chemical companies, as well as oil.
In his most recent commentary to shareholders, at the end of last year, Ober wrote: "Some of our large, integrated oil companies fell back during the period as oil prices declined. We overcame that weakness with positions in recovering metals stocks, which advanced on better pricing and improved fundamentals. Our holdings in the agriculture sector also aided results, as strong demand (from China, for example) contributed to an improving outlook."
My other two favorite funds in this group play commodities very differently.
Pimco Commodity Real Return Strategy D (PCRDX) tracks the performance of the broad commodity market using derivatives linked to the Dow Jones-AIG Commodity Index. Purchasing these requires only a fraction of the fund's assets, so nearly all of them are invested in Treasury Inflation-Protected Securities.
Launched late in 2002, the fund delivered double-digit gains in each of the succeeding years. This year it was ahead 13.1% as of March 16.
The fund, which doesn't charge a commission when purchased through discount brokers like Charles Schwab, can also serve as an inflation hedge, because its bonds, as well as its derivatives, benefit from rising consumer prices.
The ETF iShares Goldman Sachs Natural Resources (IGE), on the other hand, is a pure index fund, tracking its namesake benchmark. This is the fund I use in my model portfolio of exchange-traded funds, which I'll report on next week. (Preview: Thanks in part to this fund, that portfolio is continuing to beat the market.)
This index is weighted 80% in energy, so investors get more exposure than Ober gives while retaining some diversification in what are, historically, very volatile groups. Nine of the top 10 positions are major oil companies, but the other is Alcoa (AA, news, msgs), the aluminum producer.
The fund is up 13.1% this year, as of March 16, and 38.3% in the last 12 months.
Bubbling crude? Not yet
A spam e-mail I got last week screams "Oil Hits 27-Year High -- Sell! Sell! Sell!" The spammer calls the current market a "bubble."
Eventually, he'll be right. But I wasn't right when I used that word one year ago. Because of the expense of drilling mines and sinking wells and building refineries, natural resources producers are slow to catch up to good markets. It will be awhile before supply can catch up with demand.
And securities prices have hardly gotten to tech-bubble levels. The price/earnings ratio of ExxonMobil is about half the market level, despite massive earnings gains.
At the time of publication, Timothy Middleton owned the following securities mentioned in this article: T. Rowe Price New Era.
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