Are you feeling blue because you are spending more green on energy? We may have a cure, and it might also be a good prophylactic for your inflation ills as well.
From The Wall Street Journal, November 28, 2007, by Neil King, Jr., Why Oil Prices May Head Lower, For Now:
The Good News: Many oil watchers believe petroleum prices are set to come off highs near $100 a barrel because of the potential softening U.S. demand and hints of more supply coming to market.
The Bad News: Oil on average is still expected to cost more next year than this year as supply constraints and overall worldwide demand continue to challenge the world’s ability to produce crude.
The OPEC Factor: Prices fell yesterday on expectations of an output boost. But de facto cartel leader Saudi Arabia hasn’t indicated whether it favors a cut, and a lack of action could send prices higher.
Whatever!
The energy, commodities, and natural resource sectors tend to anticipate, or rise with, inflation. And, of course, they are subject to the laws of supply and demand. Thus, more demand and less supply will likely equal higher prices.
The question is, what are you going to do about it, if anything?
A well-diversified portfolio will have a reasonable percentage in energy-related companies including energy producers, suppliers, pipelines and so on. The “reasonable percentage” I refer to is about 11%. This is what the Vanguard Total Stock Market Index (VTSMX) carries in the energy sector. You can discover what your fund portfolio carries in the energy sector by running it through Morningstar’s “Instant X-Ray.”
If you are underweighted in energy, or simply at just about 11%, you might consider overweighting in the energy sector through a well diversified energy/natural resource mutual fund. Such a fund can serve two needs: as a hedge against your rising energy costs, and 2) as a hedge against inflation.Also note that according to Jeremy Siegel in his excellent, The Future for Investors, energy is one of three sectors (along with consumer stapes and health care) that have historically outperformed for the period 1957-2003.
Below are three excellent no-load funds and three excellent ETFs that can serve your needs. Each has a different approach, but all can serve as an excellent hedge against both energy price increases and general inflation.
No Load Energy Funds
T. Rowe Price New Era (PRNEX)--This large blend fund carries a 0.66% expense ratio, and has about 30% of its holdings in foreign stocks. It has a much lower percentage of its holdings directly in energy-related stocks, about 63%, than the Vanguard fund below. The balance of the fund is in utilites, commodities, and industrials.
Pimco Commodity Real Return D (PCRDX)--This fund offers a unique approach to the sector, but it carries a relatively high expense ratio of 1.24%. The fund tracks the Dow Jones AIG Commodity Index and uses derivatives and structured notes to capture the index, apparently without a big outlay of investor cash. The rest of the money is then invested in TIPS, an excellent inflation hedge.
Vanguard Energy (VGNEX)-- This large value fund carries a typically low Vanguard expense ratio of 0.25%, and has about 46% of its holdings in foreign stocks. This actively-managed fund has posted superb average annual returns since its inception. It is the most energy-intensive of the three funds with about 86% of its holdings directly in energy stocks.
Energy ETFs
iShares Dow Jones U.S. Energy Sector (IYE)--This ETF tracks the Dow Jones Energy Sector Index. It has a relatively high expense ratio of 0.48%.
SPDR Energy (XLE)—Like all SPDRS, this ETF tracks a section of the S & P 500, in this case those stocks that are energy-related such as oil, natural gas, drilling, and services. These stocks compose about 11% of the S & P 500. This ETF carries an expense ratio of 0.24%.
Vanguard Energy ETF (VDE)-- This fund tracks a broad energy-related index and has an expense ratio of 0.07%.
For more on using energy funds as a hedge, see the post, “Why to Buy a Sector Fund."
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