Although many investors may be looking to energy funds for some downside protection in the event of war with Iraq, I'd recommend treading carefully. Rather than focusing on the potential consequences of a war, investors should evaluate the longer-term prospects for energy and energy securities, as well as the potential role these investments could play in a well-diversified portfolio.
Look at what happened in the last Persian Gulf war. During the summer of 1990, prior to Iraq's invasion of Kuwait, crude oil prices fluctuated between $15 and $20 per barrel. Crude spiked after the invasion, reaching $41 by October. That was its peak, however, and it fell sharply after the United States began military operations in January 1991.
Interestingly, while the price of oil doubled and then retreated to earlier levels, energy-stock prices remained fairly flat. The S&P; energy sector index actually declined about 9 percent from July 31 to Oct. 11 - the same day crude prices crested at $41. Although energy stocks recovered somewhat after that, when the ground war was completed at the end of February 1991, the S&P; energy sector index was about where it had been at the beginning of 1990. Moreover, the sector underperformed the broader S&P; 500 index over the course of 1991.
Given the lackluster performance of energy stocks in 1990-1991, it should be no surprise that natural-resources funds (largely dependent on the oil sector) also limped along during the months surrounding the gulf war.
Over the past year, oil and natural gas spot and futures markets have rallied hard, while energy stocks have lumbered along, with many posting losses. The fact that energy stocks haven't soared along with commodities makes it a shaky proposition to correlate potential commodity-price movements during a new U.S.-Iraqi conflict to the movement of energy stocks (and the funds that invest in them).
For example, a further increase in oil prices may not move energy stocks at all, while a substantial fall in oil prices of say $10 (about 30 percent), which may result from the continued flow of oil out of the gulf during or after the war, could potentially be bullish for energy stocks. Many energy companies can still earn handsome profits with oil at $22 to $24 per barrel.
Since I don't have a crystal ball, I won't try to guess how the price of oil and oil company stocks will play out if there is war. However, Oppenheimer Real Asset, with exposure to commodity-linked bonds and commodities futures, would benefit if oil spikes during a war. It has already received a big boost from the near-doubling of crude over the past year - the fund climbed nearly 50 percent over that stretch while its average natural-resources peer is barely above water. Needless to say, this fund is also most vulnerable if oil prices collapse.
Some aggressive funds could soar if energy prices don't fall as far as the stock market seems to believe is likely after the resolution of the U.S.-Iraqi confrontation. These include leveraged ProFunds Ultra Energy and Fidelity Select Energy Service. These two funds, along with Oppenheimer Real Asset, are risky bets at this point - suitable for speculators only.
Rather than speculating on price movements based on various scenarios about the resolution of the current U.S-Iraqi standoff, investors should determine whether an energy-focused natural-resources fund is appropriate for their portfolios. For aggressive investors, these funds might be used to complement a growth-leaning portfolio shy of energy holdings.
Invesco Energy and Vanguard Energy offer two different takes on the sector. The Invesco offering is racier, as manager Jon Segner consistently limits the fund's exposure to the more staid integrated oil firms relative to other energy-focused offerings. The Vanguard Energy managers, on the other hand, take a contrarian tack, so they've been adding to positions in refining companies as margins have been squeezed with the rise in crude prices. Depending on your investment needs, either fund could add value to your portfolio in the long term.