While no one has been anywhere near perfect on being able to predict where oil prices are heading, one thing had been steady: the relative performance of oil prices and the prices of underlying oil stocks. For investors trying to capture rising oil prices, it had been a reliable correlation.
But, recently, that hasn't been the case. While oil has tracked very well to the underlying stocks of oil exploration and production companies -- the ones that make up the ubiquitous Energy Select Sector SPDR (XLE), companies like Exxon Mobil (XOM), ConocoPhilips (COP) and Chevron (CVX) -- oil services companies just haven't kept pace. I believe there is a fantastic opportunity here, because one of them -- either oil or the oil services stocks -- has to be wrong.
Certainly part of the disconnect needs to be blamed on natural gas prices, which have done nothing but plummet throughout the fall of 2011, and have behaved particularly badly in the first two weeks of 2012. We can't ignore the bottom-line influence that gas has had on both oil companies and oil services. But, for the drillers, despite the collapse of prices, business has never been better. Yet their underperformance has never been worse.
Here are a few charts to make the case far better than my words could:
The first chart compares the spot price for West Texas Intermediate oil with the XLE over the past six months. The second compares the price of spot oil to the Market Vectors Oil Services (OIH), the largest and most responsive oil-services ETF, containing such stocks as Halliburton (HAL), Schlumberger (SLB), Baker Hughes (BHI) and Weatherford (WFT).
Sure, the ETF containing the exploration-and-production giants is still lagging the price of oil by about 10% over the last six months. But look how badly the oil-services stocks have performed in comparison: lower by almost 30%. That's an almost unbelievable disconnect.
One of these, to put it simply, is wrong. Either oil is overpriced and due for a drop, or the drillers have become one of the best undervalued opportunities in this market for 2012. I'm betting it's the latter.
Looking at individual stocks, some of my favorites are looking incredibly cheap on the face of it, with global oil hovering at $110 a barrel and the Dow trading above 12,500. I'm talking about stocks like Schlumberger, which until Wednesday didn't seem to ever be able to catch a bid, and now still looks cheap at $72.50. Helmerich & Payne (HP) at $61 continues to tempt me, as well. Baker Hughes seems to have been particularly hard-hit by their new reliance on pressure pumping -- but, at under $50, it looks extremely attractive. Finally, don't get me started on the offshore-rig owners like Diamond Offshore (DO) and Ensco (ESV) and Transocean (RIG).
But this is one case when I believe you can reasonably just use the OIH to get that basket of all the drillers at once. It's particularly appealing given that earning season is under way, and you could get derailed by an unexpectedly bad report from one company or another.
Given how bullish I am for the broader market in 2012, I am continually looking for stocks that have underperformed in order to try and find the big winners for the coming year. I believe I have found one in the drillers. It's time to get on board.