NEW YORK ( TheStreet) -- Natural resources funds have struggled lately, losing 8.1% this year and trailing the S&P by 10 percentage points, according to Morningstar. The biggest declines occurred in August and September when investors feared that debt problems would trigger recessions in the U.S. and Europe. But portfolio managers argue that the funds are due for better days. Most of the funds have half or more of their assets in oil stocks, and the managers argue that the energy sector is poised to deliver improving earnings. According to the bullish case, oil prices should rise because of simple supply and demand. "We are not adding enough production capacity to handle the growing demand from China and other emerging markets," says Andrew Lees, portfolio manager of Invesco Energy ( IENAX - Get Report).
Since the financial crisis began to unfold in 2007, oil consumption in the U.S. and other developed nations has dropped about 4%. But demand has grown by more than 7% in the emerging markets. As a result, total consumption has climbed steadily. According to the International Energy Agency, global oil consumption climbed from 86.8 million barrels a day in the first quarter of 2010 to 89.8 million barrels in the third quarter of 2011. Much of the growth is coming from China where annual auto sales are surging, increasing from 5 million cars in 2008 to more than 10 million this year, according to Scotiabank Group. While consumption increases relentlessly, production is not keeping pace because oil companies face headwinds, says Evan Smith, portfolio manager of U.S. Global Investors Global Resources Fund ( PSPFX - Get Report). "It is getting harder to find large new sources of oil," says Smith. "You have to go to deeper waters, or you have to develop more production in less stable countries, such as Nigeria and Venezuela. That results in constant supply threats." In recent months global production has slowed because of political turmoil in Libya and Syria. A fire on a North Sea platform also caused a disruption. Smith argues that such problems should limit production and help prop up prices. The U.S. Energy Information Administration forecasts that strong demand will keep oil prices at $98 in 2012, near current levels. If that occurs, oil companies should report healthy profits.
To benefit from strong energy markets, consider U.S. Global Investors Global Resources, which has returned 19.6% annually during the past 10 years, ranking first in its category. The fund has 36% of assets in oil-related stocks, with most of the rest in mining, precious metals, and timber. The portfolio managers favor oil companies that can increase earnings by expanding production. A favorite holding is Pioneer Natural Resources ( PXD), a Texas company that produces oil in West Texas and Colorado. "They should be able to increase their production by 20% a year for the next several years," say portfolio manager Evan Smith. To own some blue-chip oil companies, try T. Rowe Price New Era ( PRNEX - Get Report). The fund has half its assets in oil and gas stocks with holdings that include giants such as Chevron ( CVX) and Royal Dutch Shell ( RS-A). The high-quality stocks have enabled the fund to deliver steady results, avoiding big losses in downturns. While the fund rarely finishes at the front of the pack, it never finished in the bottom quartile of the category for any calendar year in the past decade. Portfolio manager Timothy Parker likes Schlumberger ( SLB), the big oil-services firm that provides equipment and assistance for companies that are drilling in deep water. "Because it is a leader in technology, Schlumberger is positioned to grow as offshore production increases," says Parker. For a pure energy fund, a top choice is Invesco Energy ( IENAX - Get Report). During the past five years, the fund has returned 6.1% annually, outdoing 96% of energy competitors. Portfolio manager Andrew Lees looks for low-cost operators. A top holding is Halliburton ( HAL), which provides equipment and services that enable companies to drill and produce oil and gas. Lees says that Halliburton is a leader in hydraulic fracturing, the fast-growing technique that involves pumping fluids into rock formations. Halliburton can act as a general contractor for clients, supplying equipment and supervising drilling operations. "By relying on Halliburton, companies can reduce the time that it takes to drill a well," says Lees. Franklin Natural Resources ( FRNRX - Get Report) holds a mix of blue chips and faster-growing small companies. During the past five years, the fund returned 6.7% annually, outdoing 88% of competitors. Franklin owns companies that are benefitting from the booming oil shale regions of the U.S.
A favorite holding is Whiting Petroleum ( WLL) (WLL), which is increasing its shale production in North Dakota. "They are adding rigs, and that should result in higher earnings," says portfolio manager Fred Fromm.