David Vomund
Special to the Bonanza

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March 8, 2011
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Market Pulse: The effect of high oil on energy stocks

INCLINE VILLAGE, Nev. — As long as there is upheaval if not revolution in the Middle East, oil and energy will be in the news day after day. Local gas prices reached $4 per gallon and I’ve heard some analysts predicting $250 oil! Readers of this column know that we particularly like energy stocks (see December 16 and February 17 articles) and there is no doubt the unrest in the Middle East has sped up the long-term bullish case for this sector. Does this mean that a further spike in oil prices will continue to benefit energy shareholders? Not so fast.

Rising oil prices are a negative, except now for those who own energy stocks. I say “now” because the effect on GDP of rising prices is equivalent to a huge tax increase. People will be cutting back elsewhere, and airlines, trucking companies, UPS, FedEx and businesses of all kinds will pass along their added energy costs. So while rising oil prices are powering the energy bull market, oil and gas stocks are ultimately bets on increasing demand, and at some point ever-rising prices will curb GDP growth here and overseas. That short-term risk for the global economy is a valid concern that bears watching.

The high cost of oil is good news for alternative energy companies. For this sector a popular security is the PowerShares Clean Energy ETF (PBW). Unfortunately, alternative energy companies also rely on government subsidies and the government is in deficit reduction mode. Some consider coal as an alternative energy source (you won’t hear me say “clean coal.”) To invest in coal consider the Market Vectors Coal ETF (KOL).

As high as oil prices are now, they will skyrocket if upheaval spreads to Saudi Arabia. I do not anticipate this, but the leadership there is old and sick. Who knows what will follow it? Uncertainty about such a key area will have two effects. First, energy companies will be valued higher as oil prices rise. We’ve already seen that. Second, at some point the market will be valued lower to reflect the adverse effects of rising prices on global growth. Long ago I learned that energy stocks are bets on rising demand far more than on rising prices. It’s easy to lose sight of that amid the turmoil and soaring prices. Easy … and wrong.

— David Vomund is an Incline Village-based Registered Investment Adviser. Information on his money management service is found at www.ETFportfolios.net or by calling 775-832-8555. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.

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Tahoe Daily Tribune Updated Mar 8, 2011 05:08PM Published Mar 8, 2011 05:07PM Copyright 2011 Tahoe Daily Tribune. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.