Investing Daily

Mykonos, Greece--Crude oil prices have pulled back sharply in recent sessions alongside most other commodities. The main fundamental factor behind this drop: concerns over US and global economic conditions. The same basic growth scare is also behind the drop in global stock market indices over the past couple of weeks.

I have warned about the potential for just such a pullback in The Energy Letter as well as my two subscription-based services Personal Finance and The Energy Strategist. In both of those advisories I have recently assumed a more cautious stance near-term and have recommended taking steps to book gains and/or protect profits.

This retrenchment is hardly surprising. After all, investors are eager to protect their profits after the S&P 500 gained 40 percent in just three months and oil prices doubled from last year's lows. Nervous traders have a tendency to seize on any sliver of negative news as an excuse to sell.

Investors would do well not to panic. Long-time readers know that I prefer to follow a handful of economic indicators consistently rather than the hapless task of analyzing and parsing every economic release; too much data causes information overload, which often leads to inaction and confusion.

In this regard, I have found the Conference Board's Index of Leading Economic Indicators (LEI) to be a useful quick gauge of economic activity. I analyzed the May monthly LEI in the most recent issue of PF Weekly and encourage all subscribers unfamiliar with LEI to check out that article. For purposes of this article, however, there is only one key point to keep in mind: LEI has surged by more that 1 percent per month for two straight months. In prior cycles such a vicious stab to the upside has presaged a recovery.

There's an old saying on Wall Street that the most expensive words in business are "this time it's different."  Rather than second guess long-standing reliable indicators like LEI, I am sticking with my long-held prediction that the US will see economic growth by the end of the third quarter or early in the fourth quarter of this year.

But there's no such thing as a smooth recovery. Undoubtedly, there will be plenty of negative newsflow over the coming months, which could bring some near-term downside. This is also why the market appears to be ignoring data from the EIA showing that US motor gasoline demand is actually up year-over-year. (I see firm support for oil around $60 a barrel).

The catalyst for the next upturn in global stock and commodity markets will be a realization that the US has exited the recession and the Chinese economy is reaccelerating again. I am looking for the rally to resume in the final months of the year. I continue to look for oil to top $80 a barrel by the year's end. In short, this pullback could have a bit further to run; however, I see the move as an excellent opportunity for those that missed the recent run-up in crude and related stocks to jump aboard.

I continue to receive many questions about natural gas. My basic outlook remains unchanged.

Natural gas is already depressed thanks to a stream of unfavorable news, from expectations for a cool summer to weak industrial demand and a quiet hurricane season. 

But the fact remains that most analysts expect US gas inventories to reach their physical limits by the beginning of the heating season. This projection is already priced into gas prices.

Yet the real catalyst to watch for is a more meaningful shift in EIA-914, a report that details US gas production. The more than 60 percent decline in the US gas-directed rig count since last summer is unprecedented. Already, we are seeing signs that production is falling. By the summer's end, I believe evidence will confirm that US natural gas production has fallen precipitously. This should send gas prices back over $6 by year-end.

Secondary Offering Upside

Long-time readers know that Master Limited Partnerships (MLPs) are one of my favorite income-oriented energy plays. The value proposition for the sector is simple: yields as high as 16 percent coupled with unique tax advantages. Specifically, MLPs allow investors to defer most of the income they receive for years, if not indefinitely.

My long-time colleague Roger Conrad and I recently started MLP Profits, a service dedicated to investing in this exciting income-oriented group. 

A number of readers have asked whether I am at all concerned by the fact that several MLPs have recently come out with secondary offerings of new units, the equivalent of selling stock to raise capital. My answer is a resounding no; in fact, these secondary issuances are one of the most positive developments for the sector since the summer of 1997.

Of course, whenever a company issues new stock it dilutes existing shareholders in the near term. But the MLPs issuing new units are typically doing so for one of two reasons: to pay down high interest rate debts taken on during the credit crunch last year or to fund growth projects such as the construction of new pipelines. Both uses of capital are ultimately accretive to unitholders. After all, organic growth projects generate new cash flows to pay dividends. And paying off high rate debts also reduces debt service.

A spate of new equity and debt offerings in recent weeks is proof that well-run MLPs once again have access to the capital they need to fund new projects and generate cash for investors. This is a dramatic change for the better compared with the capital lockdown of six months ago. As capital continues to flow into the sector, look for a new wave of organic growth that will power new distribution increases.

In MLP Profits, Roger and I offer our top MLP picks for conservative and growth-oriented investors alike. I encourage all those interested in the sector to check out the service and take advantage of our risk-free trial subscription.