The Next Big Trade as Oil Prices Eventually Decline

Skyrocketing energy prices are making the headlines almost daily since last spring. Over the last 12 months, crude oil prices have more than doubled and gas prices are heading to $5 per gallon. Investors are blindly buying energy stocks and commodity funds are lunging after crude oil and natural gas futures. A full-blown mania now surrounds the energy pits.

In just about every facet of global business and consumer livelihood, high energy prices are wreaking havoc. Prices are rising, if not soaring, for most goods across the world as oil’s ubiquitous role is forcing consumers and companies alike to boost spending, reducing discretionary income and slicing corporate profits.

But surging oil is yesterday’s news. Demand destruction is underway. There will be a point when high prices compel consumers to use less oil, gasoline and other distillate fuels. This trend is already occurring since April as Americans consume less gasoline.

Since March 31st, crude oil prices have soared more than 35% -- an astonishing rally in a short period of time. At some point, a correction looms – and that’s when some sectors suffering under the weight of expensive oil will post some spectacular gains.

The Worst Business in the World

The airline industry is admittedly the worst business in the world. Soaring jet fuel prices, expensive labor costs and rising airport user fees are forcing carriers worldwide to cut routes, reduce capacity and shed labor. Many analysts forecast several big carriers, mostly in the United States, will probably collapse this year if jet fuel prices remain at these elevated levels.

Airline stocks are probably a one-way ticket to the poorhouse. That’s certainly been the case over the last 18 months as input costs have surged, mainly because of a 100%-plus rally for jet fuel. Airline stocks also earn the dubious ranking as the worst performing sector of the market over the last 12 months – even worse than the financials!

Since June 2007, the AMEX XAL Airline Index of global carriers has collapsed a formidable 62%. Over the same period, jet fuel prices have doubled, airlines have cut capacity and executives in the business are warning of the worst economic climate for the industry since 9/11. In short, these are dark times for airline executives, employees and passengers.

Turning Bullish on the Best Carriers

I’ve turned bullish on the airlines for the time in my investment career. Historically, I’ve avoided the sector like the plague; but at these bombed-out levels, ultra-low valuations and a major catalyst for rapid price appreciation on the heels of a decline in oil prices, the airlines are just too contrarian to ignore.

I’m now buying one of the best-managed airlines in the world. This blue-chip company just raised its dividend again recently – now paying an effective 8% per annum in one of the world’s strongest currencies. That yield is almost twice the rate paid by 10-year bonds in the United States and Europe. This stock is also trading at a 52-week low, still earning profits and has most of its jet fuel hedged at about $75 per barrel. How many airlines do you know that are still making money, yet alone raising dividend payments?

The way I see it, if oil prices suffer a 20% correction or more, which is highly likely after a nonstop blistering rally since last summer, industries leveraged to the price of oil or in this case, jet fuel, will rocket higher. Since the advent of the subprime debacle in July 2007, every segment of the commodity bull market has suffered a correction – except the energy complex. The rally has literally been unstoppable.

Huge Upside Leverage

As oil prices ultimately post a savage correction that is typically associated with secular bull markets, industries handcuffed by high oil prices will post major reversals.

No bull market heads straight to the Moon. Corrections do occur, and they tend to be brutal. Plus, with global governments now throwing everything they can at high oil prices, including the Saudis, the odds of a brief respite are growing more likely by the day. This is a great time to speculate on the best-managed airlines.

If oil prices decline, as I expect them to, then input costs for all carriers will decline markedly, if even for just several months. There is certainly enough room to juice this speculation for at least a quick 35% to 50% profit, possibly more. Plus, add some dividends into the picture, profitable earnings and a big bear market rally and investors should hit a home-run before December.

In the August issue of The Sovereign Individual (TSI) I’ll be recommending one of the world’s best-managed and most profitable carriers. This contrarian gem is ripe for an investment ahead of a big correction in oil prices.

Sometimes, it pays to look the other way behind the trail of a blazing bull market in energy prices. In this case, some airlines will reward investors with big profits over the next 6-12 months. I’m betting on it.