How To Play The Next Oil Price Rally

I focus on the oil and gas markets and energy stocks. But that hardly immunizes me from the rest of the macro environment - the major stock averages, interest rates and the moves from the Fed, the dollar and other currencies. It would be just plain stupid to solely concentrate on my own little world while ignoring the bigger devils that might lurk outside. I'd look like a fool putting the final touches on my own sand castle, perhaps ignoring a big wave I would see coming, if only I took a moment to look up.

And this last week was one that demanded I look up.

Stock markets dove, rose, dove and rose again, with the kind of high volatility we always think won't reappear --- and then always does. Big swings make for big anxiety, and we've got to get a grip on that before we again tackle our own beloved oil stocks.

After nearly 40 years in the markets, I'll tell you this - big volatility doesn't usually disappear overnight, despite appearing just that quickly. Experience also says that high volatility isn't a very bullish sign either. Like kids sledding on a hill - Up is a slow climb, while down is a fast whirlwind.

Since the stock market recovery began in 2009, one overarching theme has continued to power the bull market -- low interest rates from the Federal Reserve. That policy is slowly coming to an end. In addition, the last year of out-sized gains have been supercharged by the prospect of a big corporate tax cut, and then the reality of its passage in Congress. But you might wonder whether that support is already well represented in the historically very high valuations of many stocks.

It further seems to me that the stimulus of tax cuts, after many years of other stimulus, will this time have less success than in the past. I believe it won't push growth much above 3 percent, instead of the hoped for 5-6 percent GDP growth that many in the government touted when selling the passage of the tax bill.

And I think the stock market - with its current gyrations - is questioning this too.

Now, that doesn't mean I'm running out in the streets screaming to sell everything, but it does very much change my views on what to buy in energy shares and when. Going back to our small world, the energy thesis remains incredibly strong. I'm convinced the energy space contains many more undervalued and safe investment opportunities than in just about any other sector, even during this period of increased volatility. Further, we can use this time of increased volatility to our advantage, in timing the entry and exit of our investments and positioning ourselves in the less volatile and more 'value-oriented' offerings.

Let's look specifically now. I wrote last week of the tremendous opportunity being afforded by European mega-majors inside the energy space, specifically Total and Shell. Both have reacted well in the last week, and our opportunity is just beginning to show itself. In the overall market averages and particularly in the charts of almost every energy stock, there is an indication of a coming technical rally. How far that rally goes and how long lasting is more difficult to judge, but if that rally materializes, it gives us a chance to raise cash and reallocate our investments towards those with less beta and sustainable dividends.

In recent weeks, while clearly missing the enormous drop in energy shares that followed, I advised taking up to a third of positions we had accumulated mostly in independent E+P's off the table. On this next rally, I am advising a further reduction up to 50%. This extra cash will serve us well as we find further opportunities in the continuing volatility to buy dividend paying, undervalued majors.

It is not as if we won't again see opportunity to maintain full positions in high beta shale producers again. But for the moment, we will do well to heed the surrounding conditions of the overall markets and slow down our aggressive progress for a while.

By Dan Dicker