TOKYO, Japan—The Energy Strategist portfolios performed well in the second quarter. The income-oriented Proven Reserves Portfolio was up 11.4 percent, the growth-oriented Wildcatters Portfolio rose 15.9 percent, and the most aggressive, the Gushers Portfolio, ended the quarter up 28.4 percent.

This compares to a fall of more than 2.5 percent for the S&P 500 and a gain of just more than 17 percent for the S&P 500 Energy Index. And on a year-to-date and trailing one-year basis, the portfolios continue to outperform.

Since the beginning of July, however, all three portfolios have seen some selling, particularly over the past week. For that matter, nearly all sectors of the market, including energy and commodity-related stocks, have seen some selling pressure in the early days of the third quarter; of the 10 S&P 500 economic sectors, only two–consumer staples and healthcare–have managed to eke out small gains.

There are a few key reasons for this action. First, in vicious global market selloffs such as we witnessed in January and March of this year, all stocks have a tendency to sell off in synch, regardless of fundamentals or market sector.

Ironically, in such periods, the best-positioned groups can actually underperform the market temporarily because traders have a tendency to sell what they can and not what they want to sell. In other words, when the market sells off violently, traders look to raise cash by selling their winners. Because energy- and commodity-related names have been big winners, these groups are a source of cash.

Finally, the action in the commodity markets also has an impact. Oil has been all over the map this month, rallying to new all-time highs and seeing some truly huge one-day falls as well. This is consistent with the analysis I presented in the June 4, 2008, issue, Crude Realities.

To summarize the current situation, the crude oil market is being pulled in different directions. On the one hand, we have a tight global oil inventory balance; oil inventories in the developed world didn’t build in the second quarter as they normally would at this time of the year.

Also bullish for oil are continued geopolitical unrest, real questions over long-term potential for increased Organization of the Petroleum Exporting Countries (OPEC) supply, an oil strike in Brazil and continued strong demand growth from developing countries.

But there are a few items on the bears’ side of the ledger as well. First and foremost, there are very real concerns over US economic growth and declining US demand for oil. To date, this drop in US and developed world demand has been more than offset by growth in the developing world; any sign of a real drop in developing world demand would send oil back toward the $100-per-barrel level.

Shorter term, the US dollar continues to plunge to new lows against the euro but looks primed for a bounce. A rally in the dollar would be bearish for oil.

Bottom line: Look for oil prices to remain in a wide, volatile range between about $120 and $150 per barrel for the foreseeable future. I see no reason for an outright collapse in oil prices, and with oil still trading at elevated levels, I expect oil drilling activity to remain robust globally. Short-term volatility aside, this remains a bullish environment for energy stocks.

Natural gas has also been hit, though I see little fundamental underpinning for that selloff other than simple profit-taking. European Union (EU) natural gas prices remain considerably higher than prices in the US. Liquefied natural gas (LNG) inflows into the US should pick up seasonally this summer but remain weak. US gas production is higher year-over-year but that isn’t showing up in inventories; US gas inventories remain 70 billion cubic feet under the five-year average.

I feel far more comfortable with the gas market at this time than oil. And don’t forget: The heart of the Atlantic hurricane season is just ahead. This will put a floor under prices over the next four months.

This all brings up the question of how to handle all this volatility and the recent correction in portfolio holdings. I recommend taking the following steps.

First, if you haven’t yet done so, please consider the options insurance strategies I outlined June 12, 2008, in Flash Alert: Unsteady as She Goes. In that alert, I offered recommendations to hedge six big winners in the TES portfolios; it isn’t too late to follow the advice detailed there. Those who did follow these recommendations are seeing considerably less volatility as a result of recent market action.

For those unwilling or unable to buy options insurance, consider selling out of part of your position in the six big winners highlighted in the June 12 flash alert. I’ve recommended taking partial profits on a number of stocks in the past; typically, selling roughly a third of your position is enough to raise some cash and reduce volatility in your portfolio.

Second, in the past two issues of TES, I highlighted groups that can actually see upside when oil prices fall. Tanker stocks highlighted in the June 18, 2008, issue, Trading Tankers, have been among the better performers in the energy patch of late as tanker rates have remained elevated despite the selloff in crude oil. I suspect we’ll see a further spike in rates later this year as the developed world seeks to rebuild oil inventories to more normal levels.

The railroads are leveraged to strong demand for coal and agricultural shipments in the US. Demand for these products isn’t particularly sensitive to economic conditions. In addition, railroads do benefit somewhat from falling oil prices; their oil surcharges don’t quite cover their rising fuel costs in the short term. The July 2, 2008, issue, Take a Ride, highlights this group.

Third, past selloffs in the energy patch during periods of market turmoil turned out to be outstanding buying opportunities for investors. This time should be no different. In particular, given my preference for natural gas exposure over crude oil, I’m looking at a number of natural gas producers in the US and Canada as possible additions to the portfolios over the next few weeks; the correction will allow us to buy these stocks at attractive levels.