Around this time last year, I was talking oil and gas investing into a big, smelly microphone.
A friend had lined up the interview for a local radio show in Abilene, Texas. I’m not sure who was in the hot seat before me, but he must be a big fan of Skoal.
Just months later, Fox Business News wheeled me onto the newsroom set of its Vancouver affiliate to talk about the giant Marcellus Shale gas field. That’s what its viewers wanted…
After all, investing in oil and gas was “fun” back then. West Texas Intermediate climbed from $90 a barrel to $140 a barrel in just six months. Everybody was making money. T. Boone Pickens was everywhere as the “billion-dollar man.” But the market likes to punish as many people as possible, so you know what happened next…
Oil has since suffered one of the most severe drops in its history. Many oil stocks are down 75% from their highs. I hope you took my advice last year by taking profits where you had them and losses when they were small. I hope you now sit at the table for the next hand. I think it’s going to be a doozy…
Oil is the quintessential cyclical market. The price of oil moves in a series of peaks and valleys. When it peaks, everyone enjoys the boom times. When it hits a valley, it feels like a killing field. And as I said, we’ve just had a meteoric fall from a historic peak.
The shares of oil-service stocks follow the same pattern of peaks and valleys… only more so. Oil services are the companies that perform drilling, pumping, transportation, and other ancillary services for large oil companies. As the price of oil cycles up and down, the shares of oil-service stocks follow along. Except oil-service stocks’ cycles are more exaggerated in their gyrations. If oil prices are the whip handle, oil-service stocks are the tail.
The table below shows how the price to book value of these companies goes through huge boom and bust cycles. When oil stocks are booming, investors are willing to pay four to five times book value for them. When oil stocks are busting, investors will pay 1.5 times book value for them. After last year’s, crash, oil services are the cheapest they’ve been in 20 years:
Here’s the exciting part: You make gigantic returns when you buy these companies cheap and wait for the inevitable boom that follows.
Look at this simple summary of the past ten cycles. I identify each of the peaks. Look at the gains you would have made if you had bought in during the preceding bottom.
| Peak | Market bottom |
Investment period |
Oil service gain |
Oil price gain |
|---|---|---|---|---|
| 1 | Mar 1980 | 8 months | 96% | 21% |
| 2 | Sept 1982 | 11 months | 325% | 14% |
| 3 | Dec 1985 | 19 months | 133% | 92% |
| 4 | Nov 1987 | 30 months | 114% | 147% |
| 5 | Jan 1995 | 33 months | 184% | 63% |
| 6 | Feb 1999 | 18 months | 116% | 171% |
| 7 | Sept 2002 | 27 months | 45% | 141% |
| 8 | Apr 2005 | 12 months | 54% | 50% |
| 9 | Feb 2007 | 7 months | 40% | 67% |
| 10 | Jan 2008 | 5 months | 43% | 67% |
I know investing in oil services sounds crazy right now. Oil prices are depressed and earnings have fallen off a cliff. It’s a hard trade to make. But in a boom and bust sector like oil services, the “hard trades” are the ones that make you rich.
• This article was written by Matt Badiali for the free daily investment newsletter DailyWealth, and was first published on 8 April 2009