Look For A Slide, Then More Gains From These 7 Stocks

by: Brian Nichols

On November 22 I wrote an article, "Royale Energy Set To Post Large Gains In Coming Days (Along With 7 Other Stocks)," in which I called a trend that returned very large gains in these 7 stocks back in February of 2011. I decided to focus on Royale Energy (NASDAQ:ROYL) because it had key developments, along with technical reasons, that could push the stock higher.

However, because of the market's valuation, the price of crude oil and natural gas, along with the price of the 7 stocks that I discussed, I believed that it was very likely that each of the stocks would return very large gains along with ROYL. Looking back, with the exception of one, each of the seven stocks have either traded flat, or has returned significant gains; therefore I will look at market conditions to determine whether or not it's time to sell or hold these large-returning stocks.

Company Ticker Return Since Nov. 22
Royale Energy (ROYL) 73%
Lucas Energy (LEI) 40%
Chesapeake Energy (NYSE:CHK) 0%
SandRidge Energy (NYSE:SD) 22%
Samson Oil & Gas (NYSEMKT:SSN) 7%
Blue Dolphin Energy (OTCQX:BDCO) 65%
Triangle Petroleum (NYSEMKT:TPLM) 30%

As you can see, the returns from these stocks have been quite rewarding, and I was correct in my analysis that ROYL presented the best upside. The most significant factor in determining how these stocks would trade was the price of crude oil and natural gas. And although most of these companies have a substantial reliance on natural gas, for some reason, they tend to trade more with the price of crude. This opinion can be proven correct if you look at the price performance of the two commodities since November 23; crude has increased by nearly $9 and natural gas has declined from $3.56 to its current price of $3.04.

The future price performance of these two commodities will be crucial in determining whether more gains are to come or if these stocks will begin to slide. The price of crude is currently $102.63, which is near the top of its range over a 6 month period. Because of the market's current gains, 12.5% on the Dow Jones over the last 3 months, and its valuation of 12,300, I expect profit taking in the next couple weeks. The issues that has drained the market still exist, euro crisis and U.S. debt; therefore I anticipate the price of crude to temporarily drop lower.

If crude can not stabilize, then I find it hard to justify these stocks trading any higher than their current valuations. Natural gas will most likely continue its trend and trade lower, unless the government makes a strong push for the commodity in the next week, which is highly unlikely, therefore I don't see any economic factor to keep the prices of these stocks high.

Anytime a stock rises by a large margin in a short period of time, you can expect profit-taking. What I've noticed with a lot of these energy companies is that there is a significant amount of investor interest, and investors tend to hold these stocks much longer than what they would a technology company. Therefore, once these stocks post large gains, most are somewhat slow and steady to decline.

I believe that each of these stocks will trade much lower in the next two weeks; however, there are a few that I believe investors should buy once the fall is complete. These stocks have remarkable upside potential and could provide much larger gains as a long-term hold than what's been returned over the last 5 weeks.

There have been a few of these companies with significant developments to push the stock higher along with the technicals that provided the gains. For example, if crude can maintain a price above $95 then I like SandRidge Energy. It's been assumed that SD needs crude at these prices in order to operate with a profit, because of its high costs, and because of its recent $1 billion sale of interest in Oklahoma I believe the company now has the necessary capital to answer the questions surrounding its financing and funding issues. I wouldn't buy the stock at $8.30, however I do see value in the stock if it's priced below $7.50.

Chesapeake Energy is the only stock of the seven to trade flat therefore I believe it presents substantial value. The company's growing at a remarkable rate and is one of the most undervalued stock within the energy sector.

Back in November I singled out Royale Energy because I believed it had the greatest upside potential, and I still believe it has the greatest potential from its current price. Investors should expect loss in the coming weeks because of profit-taking and a potential drop in the price of commodities. The company's Goddard Wells produced 2 billion cubic feet of natural gas in 2011, and its new areas are producing 3 million cubic feet per day. Now that the company's selling its natural gas the fundamentals should drastically improve, assuming the price of natural gas stabilizes over the next few months. Yet with a market cap of only $50 million, I anticipate that with any sign of consistent sales from natural gas, the stock will trade much higher with optimism among investors. With a 3 month gain of 150%, I believe that now is the time to take profits and wait for the sell-off, which will present additional value for investors.

Disclosure: I am long ROYL.

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