With Fear Receding, Snap up Energy

by: AssetInflation

VIX is a composite index that measures the expected level of volatility in the U.S. stock market over the next 30 days, or stated more directly, it measures fear and greed. The higher the volatility, the higher the VIX trades. And lately we have witnessed our fair share of volatility, and thus the VIX has risen to elevated levels over 40. For comparison, the VIX usually trades in the 15-25 range.

Fear and Greed Heading LOWER

So if VIX is the measurement of fear/greed, then the forward futures and options on VIX would be the predictors of the future trend for fear and greed. And that direction is clearly down (from a high of 48 earlier this week).

To illustrate this example, we will use: today's current VIX. AUG futures and options on VIX (one week), and OCT futures and options on VIX.

Cash VIX index = 39.27

AUG 30 calls = $5.9

(Note A: AUG calls are trading in the hole as cost of call and strike would equal $35.90)

OCT 30 calls = $3.7

(Note B: OCT calls are trading deeper in the hole (with 2 extra months of time value) as cost of call and strike would equal $33.70)

AUG futures = 35.30

(Note C: AUG futures validate Note A and predict a drop of roughly 4 points in a week)

OCT futures = 27.08

(Note D: OCT futures validate Note B and predict a further drop over subsequent months)

Why the VIX Matters Now

The market has tumbled over 16% in less than a month (July 21st high, Aug 9th low) and many professionals have rushed to move money into "safe havens" as the fear of global depression has gripped nations worldwide. In the last three weeks, time has moved in slow motion and each day seemed to gyrate with each rumor, whether validated or not. We have witnessed 5% moves in the entire market routinely, and then watched each move reverse within days, if not in hours. The VIX peaked on Aug 8th at 48 and is trending down as fear can only last at this level for short periods of time.

In an environment where things are moving wildly, the fear prevents people from making rational decisions. As the fear subsides, common sense returns, and individuals invest based on fundamentals and future trend development. Conviction materializes and the market quickly adjusts to a more normalized environment, thus enabling investors opportunities for the future.

With Fear Receding, Snap Up Energy

Energy is the most crucial component in determining growth worldwide. As the fears of depression froze investment flows and valuation metrics across the entire energy complex, the sector has become cheap. The price of oil had dropped nearly 20%, and many stocks were mercilessly sold. With fear soon to recede, we believe that various energy investments will once again draw positive investment flows.

Short-Term Crude Strategy

For the very short-term minded investor that is looking to quickly play the move, we believe the Long ETF for crude oil (NYSEARCA:USO) ($33.30) is a short-term buy. The 52wk range is 30.31-45.60, and we have a target of $40.

Long-Term Integrated Strategy

For those looking for beaten down integrated oils, we like Conoco Phillips (NYSE:COP) ($65.52) and Exxon Mobil (NYSE:XOM) ($71.58). Both companies offer fantastic yield, great portfolio of oil assets around the world, and top-notch management; and both are considerably lower over the past few weeks. For more information on XOM click our previous article and on COP/XOM fundamentals click this recent article.

Mid- and Long-Term Producer Strategy

For those looking for a little more beta and more direct correlation with the price of crude and natural gas, we like both Apache (NYSE:APA) ($103.12) and Anadarko (NYSE:APC) ($73.37). Apache has been hard hit recently, dropping almost $30 from its $129 highs just last month; and we would expect a mid-term resumption of their upward trend. Andadarko has suffered to a lesser degree, but the stock is down about $12 in a little more than 3 weeks. It was just a few weeks ago that everyone was worried about containing oil prices at the $100 mark, and solid producers like APA and APC will be part of the solution.

Mid- and Long-Term Coal Strategy

For those that are looking for beaten down coal companies, Patriot Coal (PCX) ($14.52) and Peabody Energy (BTU) ($48.56) are two excellent opportunities. Patriot Coal is the smaller of the two and a more aggressive selection, but is trading at half of its 52wk high of $29.20. Peabody is much larger with a $13B market cap, trading near its 52wk lows (range 40.79-73.95), and pays a small dividend. Both companies should benefit as all energy forms are embraced.

Mid- and Long-Term Natural Gas Strategy

For those that prefer natural gas, we like Comstock Resources (NYSE:CRK) ($25.32) and Encana (NYSE:ECA) ($26.00) as our favorites in this sector. Comstock is the smaller producer and our aggressive selection, while Encana is the larger with almost a $20B market cap. Both companies are not as beaten down as the coal or oil segments, but natural gas itself has been an unloved commodity for years. As new industry infrastructure continues to be developed, we believe the entire sector will continue with their solid growth trajectory.

Mid- and Long-Term Refinery Strategy

For those looking for refiners, we like Valero (NYSE:VLO) ($20.76) and Tesoro (NYSE:TSO) ($20.27) as our favorite independent refiners. Valero is the largest independent refiner and has a good mix of refineries around the country. VLO has dropped over 20% in last few weeks, and is off about 33% from their 52wk high (range 15.49-31.12). Tesoro is smaller than Valero, but offers more upside due to its volatility. Both Tesoro and Valero are trading at roughly 7x this year's estimated earnings, and both offer direct opportunity to capitalize on the fact that the U.S. refinery capacity is limited.

Energy is truly a valuable commodity that is always in demand. As the market volatility winds down and fear dissipates, investors will focus more on the long-term needs of the global economy. Energy companies are the engines of growth, and the good ones will profit handsomely. It is time to act, while prices are still artificially depressed; because as the VIX points out, fear does not last forever.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in XOM, COP over the next 72 hours.