Less than three months ago, on Feb. 11, West Texas Intermediate (WTI) crude closed at $26.19/bbl. There were any number of predictions that the price would fall to $20, $10, or even $5/bbl. After all, global crude inventories were extremely high, OPEC was flooding the market, and if that weren’t enough it had just been announced that sanctions on Iran would be lifted, allowing that major oil producer to ramp up its exports.

From the Jan. 23 issue of The Economist:

“They [crude inventories] will continue to grow, especially if demand slows by more than expected in China and the rest of Asia. Forecasting the oil price is a mug’s game (as the newspaper that once speculated about $5 oil, we speak from experience), but few expect it to start rising before 2017.”

Yet as I write this oil is at $46.51/bbl, up 78% from those February lows. If you are kicking yourself for not moving money into oil companies while crude was in the $20s, you certainly are not alone. It is very difficult to invest contrary to conventional wisdom. Everyone around you is telling you it’s a bad idea. A year ago conventional wisdom (i.e., most analysts) deemed Apple (NASDAQ: AAPL) a no-brainer buy. Nobody would have questioned the wisdom of that investment, yet it has suffered a 25% decline over the past year.

There are two things I know. One is that oil in the $30s isn’t sustainable. That condition may persist for a while, but only until the market rebalances. That means that if you see oil prices in that area, it is probably a good idea to shift money in that direction. It was a smart move in 2008, and I think it will prove to be a smart move in 2016. As oil prices move higher the energy sector will becomes less of a no-brainer, because the gains by oil stocks often outpace the rise in the oil price.

Investing while prices are falling means you may be early. If you did so when oil first dropped into the $30s you ultimately saw it drop into the $20s. You heard the scary warnings that prices would continue to fall. But you can’t consistently time the market. I got lucky in 2008 and shifted money in almost at the bottom. In 2015 I was early, so I saw months of paper losses that have now finally turned into paper gains. You win some, you lose some, but you have to persevere and execute your strategy.

I said that there are two things I know. The second is that natural gas prices under $2.50 per million British thermal units (MMBtu) aren’t sustainable either. In fact, since 2000 the price of natural gas has breached that level three times. Each time it happened, natural gas prices more than doubled within 18 months.

The only real exception to this pattern over the past 20 years happened in 1997, when the price dipped below $2.50, rallied back above $3, but then sort of languished near $2.50 before rallying in 2000. It’s possible we could see that again. Prices could hold near current levels for a year because natural gas inventories are very high in the U.S. But gas will rally and it is likely that, as with oil, it will rally well before it is obvious that inventory levels are returning to normal.  

This pattern of natural gas price spikes is predictable, but the time frame isn’t. It’s a certainty prices will spike. Will they spike this year or next year? Will it be like 1997 again, which saw flat prices for four years before prices tripled? It doesn’t really matter for long-term investors, as long as you buy companies that aren’t overly leveraged. You want those that can withstand these prices for a year or three if necessary, and if the spike comes sooner you will reap the rewards without undue risk.   

If I scan the list of energy stocks that have rallied since February, the biggest gains came from the most highly leveraged producers. That’s to be expected, because many of these producers had been given up for dead. But in most of these cases, the stocks are still down year-over-year despite the rally across the energy sector. Unless you like to gamble, these producers are better left alone.

Natural gas stocks have rallied, but in most cases they have lagged the oil producers (i.e., those that produce oil predominantly). Many solid natural gas stocks that should rally as natural gas prices recover are only up 20-25% from February, in contrast to the 50-100% and upwards gains for many of the oil producers.

Right now natural gas companies look like good risk-reward options. We want to limit downside risk in case it takes demand a few years to catch up. There are many demand drivers unfolding (LNG exports, power companies switching to natural gas, a renaissance of chemical manufacturing), but should natural gas prices remain depressed for another year we don’t want to get caught holding a bankruptcy candidate.

Fortunately, we have some great options in our portfolios. In fact, Marcellus natural gas producers Cabot Oil & Gas (NYSE: COG) and EQT (NYSE: EQT) are among our three highest rated Best Buys. (See the next article for more on Cabot.).

Another worth considering is Peyto Exploration & Development (OTC: PEYUF; TSE: PEY). This Canadian producer has a long, consistent track record of delivering superior returns, and recently posted an annual profit despite the difficult market conditions.

Conclusions

Successful investing requires discipline and consistency. Sometimes you are going to absorb losses, but you can’t panic. Take losses if the fundamental outlook for a company changes, but don’t bet against the sector when oil is below $40/bbl, or when natural gas is below $2.50/MMBtu. Those are historically the exact times you should invest in the sector, even though conventional wisdom will be telling you that there is no hope.

Following the herd too often leads to a slaughter. You have to have a plan, and you have to maintain discipline. Think about the likelihood that natural gas remains at the present level of $2/MMBtu, and then decide what you are going to do about it.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)