Break Down the TrendFirst, start by breaking down the trend of rising oil prices and the falling dollar into three time frames. In the short term, there's the truly scary volatility of oil prices. The January futures contract for light sweet crude is trading near $41 a barrel. That's more than 30% off October's high. We're talking about a 30%-plus move in two months. In the intermediate term -- say five years -- there's the very tricky transition as the market stumbles around searching for alternatives to high-priced oil and gas. The mix will include contributions from coal, ethanol, wind, nuclear, other sources and conservation -- as well as continued reliance on high-priced oil and gas. But the profitability of investing in any one of these will hinge on how quickly the market moves to find substitutes for oil and gas and how big the move is toward any particular substitute. In the long term -- say one to two decades -- we can list the technologies that are likely to be part of the energy fix. But it's devilishly hard to point to specific products and predict their relative market share, or even to ballpark the point at which any of these products will hit the sweet spot in the growth curve. And given what we don't know about global supplies of oil and gas, putting a price on energy stocks in this time frame takes on even more uncertainty. Of course, while all of this is happening in the energy marketplace, the dollar will be dancing its own jig. At times, the U.S. currency seems headed for the dustbin of history. But that very pessimism is likely to produce short-but-significant rallies in the dollar.
Strategize by Time FrameThe next step is to develop a stock-picking strategy for each time period. In the short term, for example, recognize that although the prices of energy stocks are trending upward, the short-term volatility in oil and gas prices will spill over into the price of energy-company shares. Your choices:
- Ignore this volatility and stick to the long-term trend;
- Buy on the dip to add to existing positions in the sector; or
- Trade in (on the dip) and trade out (on the peak).