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  1. Home
  2. / Investing
  3. / Energy

Buy This E&P Basket and Let's Celebrate in 2016

Strap in and wait for the market to re-price these names to sane levels.
By JIM COLLINS
Dec 10, 2015 | 12:00 PM EST
Stocks quotes in this article: ENRJ, EXXI, EPM, GST, GDP, LLEX, MHRC, PDCE, TRCH, VYEY, AAPL

As the S&P 500 drops into a loss for 2015, I continue to believe the way to play this market is to profit from quick pops and reinvest gains in fixed-income securities. In my column Tuesday, I listed 10 oil & gas exploration and production (E&P) stocks that I believe are capable of generating such quick gains. Here is that list again:

EnerJex Resources (ENRJ)

Energy XXI (EXXI)

Evolution Petroleum (EPM)

Gastar Exploration (GST)

Goodrich Petroleum (GDP)

Lilis Energy (LLEX)

Magnum Hunter Resources (MHRC)

PDC Energy (PDCE)

Torchlight Energy Resources (TRCH)

Victory Energy (VYEY)

I have met with the management of all of these E&Ps in the past few months, and as the market has discarded them, I won't. I'll keep writing on the small/microcap E&P sector, even as these names have been pushed down to mini-market cap levels. While these companies may not be widely known, the scope of opportunity is so different from the high-profile names.

Of the 10 stocks I mentioned in the column that was posted before Tuesday's open, six of them -- ENRJ, EXXI, GST, GDP, LLEX and PDCE -- have already gained at least 4% in 1 1/2 trading days. Apple (AAPL) is just not going to do that in days or weeks, and I don't see 4% upside in AAPL from these levels in the intermediate-term.

Honestly, I don't want to own Apple or the "average stock" going into 2016. We're already down for 2015 -- albeit less than 1% and that could change today -- but in these machine-driven markets, momentum seems to beget momentum.

Next year scares me from a stock market perspective, with geopolitical and domestic political risk seemingly growing by the day. The world is just not a safe place, as even San Bernardino -- in the heart of California's sleepy Inland Empire -- has been attacked. The response to that attack from politicians on both sides of the aisle indicates to me that the lead-up to next November's Presidential election is going to be nasty -- likely nastier than any in my lifetime -- and I just don't think the stock market will like that.

So, the key to the 10-stock portfolio I laid out in Tuesday's column is described by a term from the oil & gas industry itself: a statistical play. A statistical play defines an area of exploitation where well performance will vary greatly from well to well, but the average performance is actually quite predictable.

And that's how I see this list. It's entirely possible one or two of these companies could file for bankruptcy protection in the next quarter. However, I think the majority will not. If two of the companies file for Chapter 11 and three of them double then you still have banked a 10% return even if the other five do nothing. And microcap E&P stocks never "do nothing." It's the shotgun method as opposed to the rifle method.

Remember -- and this is a crucial investing lesson -- the stocks will begin to recover before the underlying commodity does.

It's too damn easy to short oil, as very, very few contracts ever reach the stage of physical delivery to Cushing, Okla. The vast majority of contracts are settled prior to expiration.

But individual stocks aren't that easy to pick up, and this group has seen massive amounts of short-selling, meaning the opportunities for short-covering rallies are widespread. That's how 2% moves become 20% gains.

So, buy a basket of these names to reduce your company-specific exposure, strap in and just wait for the market to re-price these things to levels that are something resembling sane. When that happens, drop an e-mail at jim@portfoliogurupost.com and we can celebrate virtually over a glass of Scotch (I prefer Glenmorangie's 12-year old.)

Yes, dealing in small stocks in an industry that is hated like none I've seen in 25 years can drive one to drink, but let's focus on toasting victory rather than drowning sorrows from defeats.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

At the time of publication, Collins' firm owns EXIXF, EPM-A, GST-A, MHRC, MHRCL and MHRCP. Please note that small-cap stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

TAGS: Investing | U.S. Equity | Energy

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Be careful about drawing a comparison with dry bulk shippers and hydrocarbon names. They're two completely different undertakings.

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