by Marin Katusa, Katusa Research:
As we entered the summer months, many investors wanted to believe a terrible time for oil and gas stocks was nearing an end. Now that we’re six weeks into summer, we see that’s not the case.
During the first half of 2017, oil and gas stocks were among the market’s worst performers. The Dow Jones US Oil & Gas Index declined 17%. Some of the more highly levered oil and gas stocks fell twice that much. After such a big fall, value-hunting investors began buying. But last week, we saw that oil and gas stocks are still vulnerable to waves of selling that send them to 52- week lows.
Take Pioneer Natural Resources for example. In the mutual fund and hedge fund world, it’s considered one of the premier independent oil and gas companies… a “go to” stock for getting exposure to the oil sector. After reporting second quarter earnings and stating it would delay drilling projects, Pioneer stock was crushed 17% in the following two days and hit its lowest level of the year. A true wipeout… in one of the sector’s best operators.
Pioneer is not an isolated case. Last week, a handful of other oil and gas stocks hit yearly lows, including Apache, Range Resources, Southwestern Energy, Parsley Energy, RSP Permian, Sanchez Energy, Carrizo Oil & Gas, and Noble Energy.
An especially notable loser last week was Canadian producer Seven Generations Energy. It’s a major player in one of my favorite areas for investment, Canada’s prolific Montney shale. It has exceptional assets. However, quality was no sanctuary last week. After reporting second quarter earnings, “Seven Gen” dropped as much as 18% and reached a fresh yearly low.
***Regular readers will recall my writings on the oil patch back in June. At the time, I stated that although the oil and gas sector had suffered massively in 2017, more pain was on the way. Last week’s declines show that my expectations are being met. They are also moving us closer to a significant bottom in the oil sector. I’m getting closer and closer to pulling the trigger on high-quality names marked down to discount prices. More on this to come.
How Index Funds Are Impacting the Gold Sector
Over the past seven years, index funds and exchange-traded funds (ETFs) have dominant forces in the market. Typically, these funds don’t try to beat the market. They are the market. They own broad indexes (like the S&P 500) or sector groups (like retail or energy). And they’ve become widely popular with investors.
Index funds are so popular that many investors are warning about the effects index funds are having on the overall stock market. Since index funds buy stocks based on an index – not good old fashioned fundamental analysis – they have the potential to make popular, overvalued stocks even more overvalued… and warp the market.
What you may not have heard however, is how ETFs are influencing returns in the gold stock sector. Since spring, the smaller mid-tiers (sub 400,000 ounces of gold production annually) have experienced significant selling which we will explain later. This significant selling of the smaller mid-tiers has lowered the overall mid-tier index relative to its performance to the senior index in past years.
And still true today, as a group, the mid-tiers overall are cheaper than the senior gold producers.
The chart below is the Katusa Senior Gold Index which is made up of the 15 global publicly listed primary gold producers that produced over 1 million ounces of gold in 2016. The senior golds have outperformed the Katusa Mid-Tier Gold Producers which is made up of 25 publicly listed primary gold producers that produced between 250,000 and 1 million ounces of gold in 2016.
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