As we move ever closer to the new year, bonds have drifted lower as investor confidence in the government's ability to get a fiscal cliff deal done has wavered. Gold has been pulling back for some time on fears of a continuing weak economy. Even the stock market has slipped in the past week. Crude oil has also been weak, as futures have traded off the highs and bounced between $85 and $92 or so for the past few weeks. The markets seem to be saying we are going to do a fiscal Thelma-and-Louise and go off the cliff into recession.
I have no clue if we will or not. I suspect we will, or at best, the politicians will come up with a compromise that no one wants and which will further unsettles the markets. I do know that fears of economic weakness and subdued demand have kept a pretty firm lid on energy and energy stocks, and at this point, many of them are just too cheap not to own going into next year.
Energy stocks have bounced around but gone nowhere for the past five years. The energy sector return has basically been a flat line. The sector's performance this year has not been much better; it has returned a fraction of the broader markets gain. Traders have been able to make a few bucks in energy stocks, but investors have not done as well.
I think we are now at the point where oil does not have to go up a whole lot for the stocks to rally. Many of the companies in the sector are now trading below tangible book value and seem to offer a strong buying opportunity. Although many doom-and-gloom oriented speculators are predicting $40-per-barrel oil, I do not think that is going to happen. I have learned over the years that if you want to know what's going to happen in oil prices, pay attention to what the king of Saudi Arabia says. Anytime prices move away from the levels he indicates please the kingdom, they quickly correct. His most recent comments indicated he felt current prices were fair to buyers and sellers. I think it unlikely that prices will go much below $85 per barrel for any extended period of time.
The other positive factor for energy related stocks is going to be the continued political discussion about energy independence. This has been a hot button issue with much of the talk swirling around alternative energy solutions. The simple truth is that these will work someday but that time is not now. They simply cannot supply our energy needs at a reasonable cost. We will need to use our fossil fuel resources like oil and gas to reach our national goals.
This should end up being fantastic news for domestic drillers and service companies. My favorite in this space is still Nabors (NBR). The stock has moved up a few ticks off its absolute lows, but the shares still trade at just 80% of tangible book value. Nabors is the world's largest land drilling contractor and has the majority of its operations in the U.S. and Canada. The company has a significant presence in the unconventional oil-and-gas fields and they will benefit from any increase in drilling activity and firmer oil pricing.
I have owned shares of Tesco (TESO) for some time now. They have moved a little higher and trade right at tangible book value right now. I think you can buy a little stock now and add on a scale if we see a market pullback in the first quarter. The company has fixed the manufacturing issues with its top drive systems and orders should begin pick up again for that division in the first quarter. Case running jobs increased by 10% this year and they are expanding into case job running for the faster growing deep water drilling operations. The company is well positioned to benefit from increased drilling both on and offshore and is too cheap given its bright prospects.
These are my top two picks, but by no means my only ones. Swift Energy (SFY) has onshore drilling operations as well as shallow water rigs in Texas and Louisiana and trades at 60% of tangible book value. I missed a chance to sell Penn Virginia (PVA) at a nice gain, but with the shares trading back at 30% of tangible book value, the company has enormous upside if management can get its act together. If Carl Icahn and Mason Hawkins are successful in executing a turnaround, then shares of Chesapeake Energy (CHK) could post impressive gains over the next few years as well.
Energy stocks have struggled of several years now. Many of them trade at levels where the stocks should go higher to reflect their asset value -- if oil just doesn't go down too much more. The level of pricing also makes a merger wave likely as competitors look to buy quality assets at bargain prices. I do not make sector or market calls, but the large number of safe and cheap stocks is likely leading to a large energy presence in value portfolios for the next few years.