Investing information you must know if you want to buy oil stocks

The Resource sector, which includes oil, is one of the most volatile, and no one can accurately predict future oil prices. This is why we continue to advise against overindulging in Canadian oil stocks.

However, for those investors looking to buy oil stocks, we have provided some important information for you below.

Resource stocks, though volatile, tend to rise with inflation

The resource sector is subject to wide and unpredictable swings in the prices it gets for its products. For example, in the rising phase of stock market cycles, when businesses are booming, resource demand expands faster than resource supply, so resource prices shoot up. This balloons profits at resource companies. When the economy slumps, resource prices fall, and this drags down resource profits and stock prices.

In addition to rising and falling with the stock market cycle, however, resource stocks have a history of rising along with long-term inflationary trends. This gives them a rare ability: they can provide a hedge against inflation.

Buy oil stocks successfully with these tips

• Invest in oil and other energy stocks that own diversified drilling sites in multiple geographic locations where exploration has been successful in the past.
• Buy oil stocks that use innovative new drilling and exploration techniques. Staying ahead of the curve will keep them in business.
• Look at the market cap of oil and gas companies versus the estimated value of the reserves they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of their findings.
• Junior energy stocks are risky to invest in, because it’s relatively cheap and easy to launch a penny oil or other energy stock and sell stock to the public.
• Stay away from energy stocks operating in insecure and politically unstable regions, or in countries with little respect for property rights and the rule of law. Resource extraction is inherently a politically vulnerable business; you can’t move the oil wells to another country, and local citizens sometimes believe that a foreign resource company is robbing them of their birthright, even though they need the foreign company’s capital and expertise to get any value out of the ground.

Buy oil stocks from top resource companies

The top resource companies acquire a lasting competitive advantage by developing expertise in engineering, financial and political areas.

This expertise is another type of hidden asset. It doesn’t appear on the balance sheet, but it gives resource stocks an advantage in every project they undertake.

Resource companies do sometimes turn out to have hidden environmental liabilities, as do companies in other sectors. But the top resource stocks also create their own hidden assets. They accumulate rights to promising acreage long before the land rush starts. They have the technical and political skills they need to foresee and deal with environmental and political obstacles.

This expertise becomes more important as resource technology advances. For instance, recent advances in oil and gas drilling technology helped bring on the plunge in oil prices. The new technology made it possible to vastly increase oil production, even from deposits that were once considered worthless.

Advice for investors who want to buy oil stocks

Our advice is for most investors to maintain some exposure to the oil industry as part of the Resources segment of your portfolio. Overall, though, now is a particularly good time to stick to our three-part Successful Investor approach: Invest mainly in well-established, mainly dividend-paying stocks; spread your money out across most if not all of the five main economic sectors; downplay or avoid stocks in the broker/media limelight.

Put perhaps half the money you intend to invest in the Resources sector into oil and gas stocks. But only buy these or any stocks if you are prepared to hold them for at least a while.

Above all, when considering how to invest in oil stocks, resist the urge to go overboard, particularly in high-risk oil investments such as junior oils, futures, options and so on. They are as risky as ever, and they may especially fail to thrive in a slow oil recovery.

Do you buy oil stocks? Do you fear the volatility in this resource sector or do you feel comfortable enough with the oil investments you’re holding? How much of a drop in oil prices would lead you to sell the oil investments you currently have? Share your thoughts with us in the comments.