Oil Prices Are At Two-Year Lows - Should You Buy Now?

By: Eric Winter of Street Authority

Stock exchanges are not alone in seeing prices pull back lately. In at least one case, however, that is actually a good thing.

Drivers both state-side and abroad have no doubt felt the pain at the pump subsiding this fall. In the United States, many gas stations are now hawking unleaded for under $3.00 a gallon -- a welcome sight in my eyes, at least.

Those lower prices have come at a cost to some portfolios, however.

Oil prices have been steadily declining since making highs in June, falling from north of $104 to around $81 at the time this article was written. Considering that nearly every industry is affected by oil in some way, this means there’s a good chance some of your holdings have fallen in tandem.

Naturally, oil explorers, producers, and those along the supply chain have been hit the hardest. Exxon Mobil Corp. (NYSE: XOM), the world’s largest oil company by revenue, has fallen 11% since July. In contrast, the SP 500 is only down 2.6% in the same time period.

The big question now: have prices reached a bottom, and is it time to go long big oil?

A recent pop in energy stock prices across the board leads me to believe that the answers may be: Yes. Analysts and CEOs are coming out publicly in support of many oil companies during this earnings season, showing that a buying opportunity may be presenting itself in this slump.

This perceived value is making itself known predominantly in beat-down price-to-earnings ratios. Many drillers, service providers and the like are trading at single-digit P/E multiples, garnering the attention of both fund managers and research shops alike.

See below for a list of some energy equities and their forward P/E ratios:

So how can we profit from a potential upswing?

Don't complicate things by trying to pick individual names or playing with futures. I suggest going with an ETF that is heavy on the super majors. Why is that? Simple: the larger oil companies are well-capitalized and have long histories of weathering these cycles.

The Energy Select Sector SPDR ETF (NYSE: XLE) meets that requirement beautifully and also stands out as the largest energy ETF.

XLE peaked in June at $101.52, only to fall to $77.51 just four months later. Since that low, however, the ETF bounced up to $86 in just one week of heavy buying.

Investors are putting their money where their mouths are, with inflows into XLE amounting to $1.1 billion in October so far. In addition, research arms of firms like Bank of America and Jefferies have hit the newswires this past week, reiterating buy ratings in many of the companies that make up XLE.

Ideally, I’d like to see XLE head south towards that $77.51 low again, only to receive more buying and bounce again. This would show that real support exists at that level. I can’t say if oil prices are done stretching just yet, so I see this as a safer entry method.

Risks to Consider: Timing oil markets is difficult -- the commodity is driven by seemingly every factor under the sun. Fundamentals, geopolitics, international regulatory bodies and a slew of other variables all weigh into the price. Waiting to see if XLE heads lower may mean you may miss the trade entirely. But if XLE reaches its recent bottom again and falls through, then investors could be looking at some nasty losses before it levels out again.

Action To Take -- With oil prices now at two-year lows, many analysts and investors are focusing more attention on the commodity. XLE’s recent bounce has me looking for a good entry if buying support holds. In the meantime, I’ll be enjoying a heavier wallet and a fuller gas tank.

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