ENERGY INDUSTRY OUTLOOK

INDEPENDENT EXPLORATION AND PRODUCTION
Exploration and production stocks (as measured by the XLE, Energy Index) rose 6.1% in the third quarter after bottoming out on August 18 after an 18.6% year-to-date decline. As always, the performance largely mirrors the movement in West Texas Intermediate oil prices. The November 2017 futures contract rose 15% during the quarter and is now trading above $52 per barrel. Some of the rise in oil prices can most likely be attributed to the effects of hurricanes in the Gulf during the month of September. However, it is worth noting that the U.S. reliance on the Gulf for oil has been greatly decreased in recent years and refinery outages could limit the demand for crude oil in the near future. Longer-term, we continue to believe that oil prices are locked in a $45-$55 range which could test individual company cash flow and profitability. We continue to maintain a cautious outlook towards the group. We favor companies that maintain strong balance sheets, have a large hedge position, and operate in regions with low operating costs.

MINING AND METALS INDUSTRY OUTLOOK

Mining companies (as measured by the S&P Metals & Mining Index, XME,) rose 7.4% in the third quarter, adding some excitement to the group for the first time since the runup last January and February. Interestingly, gold and silver prices only rose 3.2% and 0.5% respectively during the quarter. The strength in the group also can’t be explained by a movement in the overall market as the S&P 500 rose a modest 3.5% during the quarter. We believe the strong performance represents a general sector rotation into commodity sensitive stocks as investors anticipate rising inflationary conditions. We share this belief and believe the future for precious metal prices remains bright. We look for strong economic conditions to increase the demand for gold and silver. At the same time, decreased exploration and drilling in recent years will limit the amount of new supply brought to the market. The result will be a decrease in the glut of supply hanging over the market and eventually higher prices. We favor companies that are cash flow positive but also have assets under control that they can exploit should prices rise.