INVESTING: Energy stocks had their run, but they may storm back

People don’t seem to spend as much time talking about high oil costs today as they did a year ago. Perhaps we’ve gotten used to them. Maybe the negative effects will be felt later. But one thing seems obvious: Energy stocks have recorded at least a short-term top. Let’s see what happens next.

The incredible rise in oil over the last three years has turned up the volume in the debate over solutions. Washington passed an energy bill last summer, but then turned down opportunities to increase drilling in Alaska. More focus has been put on Canada lately, with its huge supply of oil sands. And Toyota is seeing record margins on sales of its hybrid car the Prius, which I am proud to have owned for two years.

Back in June, I wrote a column about alternative fuels such as ethanol. Now that the energy bill has passed, Indiana will soon find itself awash in ethanol. In less than three years, we will be one of the largest ethanol producers in the world. At the time, I highlighted Archer Daniels Midland as a stock that could benefit from greater ethanol consumption. The stock was at $20 then; it’s selling for $37 today. Eighty-five percent in nine months. That will help take the sting out of higher gas costs!

I sold all my energy stocks in the middle of January because I felt they were too extended. They bounced hard that first month, and I felt the risks were high if I held them. My opinion at the time was I would be buying them back in a few weeks or a few months. Evidence has popped up since then, however, to keep me from the buy button for the time being.

Rydex is a mutual fund company with funds that mirror indexes and sectors. The firm offers 17 sector funds, ranging from banking to real estate to electronics. It also has two energy funds.

An astonishing thing happened early this year. By the end of January, 38 percent of all investor money in the 17 sector funds was in the two energy funds. That is the equivalent of nearly everyone betting the same way. The move was so far off the charts we haven’t been able to fully quantify it yet. There are some wise technicians, however, who say such a statistic foreshadows something more dangerous than just a short-term top.

Another reason to be cautious on energy stocks, at least for the near term, is turning up in the options market. Increased optimism during market declines by investors shows a lack of fear and a belief that the rally will quickly continue. As oil has pulled back, investors have been buying more calls and doing so on increased volume. This is the exact opposite of what you want to see if you are bullish on the energy sector. I have a feeling these stocks could underperform a while longer.

An opportunity to play energy stocks could be approaching in three or four months, though. With record-high temperatures this winter, we could experience even greater hurricane levels this summer. Let’s hope that’s not the case. But such speculation could lead to buying in the sector in June and July. Some money could be made, especially if the shares fall enough in the near term.