4 ways to cash in on $100 oil

$100 oil can grease your portfolio.

(MONEY Magazine) -- Given recent experience, you might naturally assume that the sharp run-up in oil prices over the past several months will soon cause the economy and financial markets to seize up.

After all, every recession since the 1980s has been either preceded or accompanied by just such a crude awakening. And every time oil soared above $100 a barrel and stayed there for a stretch -- in 2011, 2008, and in the early '80s (on an inflation-adjusted basis) -- the gears of global growth ground to a halt, stalling stocks.

While you can't pin all of the blame for these slumps on the surging cost of crude (the global financial collapse and the euro debt crisis had a little something to do with the last two), triple-digit oil prices surely can't be a sign of good times ahead for investors.

Or can they? So far this year, the Standard & Poor's 500 has churned out double-digit gains despite $4-a-gallon gasoline, suggesting the relationship between oil prices and your investments is more complicated than you might think.

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"It's a two-way street," says University of Michigan economist Lutz Kilian. "It's not just what oil prices do to the economy; it's what the economy does to oil prices."

Expectations of strong growth in the developing world have been a key factor keeping oil prices high by historical standards for more than two years now; it's the latest spurt, from $90 last fall to $105 today, that is being driven by Middle East tensions surrounding Iran. Plus, says Eaton Vance portfolio manager Walter Row, "there are other issues [affecting stocks] that are more dominant than oil," such as the rapidly improving domestic economy.

The key to profiting in this environment is to understand how current conditions differ from prior times that oil prices spiked, then to identify the opportunities that are being created for savvy investors as a result. Here's how to play it.

Invest in energy ... but through natural gas, not oil.

Last time: 2011 was a perfect example of how risky it can be to invest in energy when oil prices are rising sharply. Shares of exploration companies and oilfield services firms jumped in the first four months of the year as crude surged 33%, from $85 a barrel to $113, because of political instability in Libya amid the Middle East protests that led to the "Arab Spring."

But the ferocity of that run-up, at a precarious time in the recovery, stoked fears that the world was headed for another downturn. So prices quickly slid back below $100 in the summer, and oil stocks tumbled 20% from May to December, erasing the earlier gains.

This time: For starters, the economy has improved. Europe is in much better shape now, and no one is talking about a U.S. recession.

Also, this oil price hike has been nowhere near as severe as last year's, at least not yet. By April of 2011, for instance, a gallon of gasoline cost 35% more than a year earlier. Today prices at the pump, while uncomfortably high, are just 8% higher than a year ago. Ned Davis Research studied the relationship between gas and equities and found that stocks start to slow only once fuel costs rise 20% or more over six months, and start to fall when prices are up 30% or more over a year. True to form, stocks peaked last year at the end of April, and had given back nearly all their gains by year-end.

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There's one other key distinction: Energy prices last year increased across the board. This year coal has been flat, as growth in China, the world's largest coal importer, has slowed and utilities are relying more on other energy sources to generate electricity. And natural gas has sunk more than 30% because of record production in the U.S.

Due in part to these offsetting trends, analysts think oil demand could grow by about 1 million barrels a day in 2012, after declining by 300,000 barrels a day at the end of last year. Rising demand amid high prices would be great for oil company profits and stocks. Yet betting on these shares remains a high-risk proposition, no matter how Mideast developments play out. If Iran blocks crude shipments through the Strait of Hormuz, for instance, prices could jump to, say, $150 a barrel, and demand would probably slow. On the other hand, if geopolitical threats die down, prices could sink like last summer, taking oil shares down with them.

Fortunately natural-gas prices are already way down -- selling for about the equivalent of $15-a-barrel oil -- providing you with a safer way to invest in energy stocks.

Best strategy: There are exchange-traded funds that let you bet on natural-gas prices through futures contracts, but that's a risky way to invest in a sector that's volatile to begin with. Stick to shares of gas companies, and "focus on low-cost producers with good balance sheets that can thrive in a sustained period of low prices," says Bradley Hinton, director of research for the Weitz Funds. He likes Southwestern Energy (SWN). Already a low-cost leader, SWN has trimmed its drilling costs by 7% since 2008.

American Century fund manager Michael Liss favors Ultra Petroleum (UPL). "Don't let the 'petroleum' in its name fool you," he says, noting that Ultra owns wells throughout Wyoming and Pennsylvania's Marcellus Shale, where gas is fairly easy (as in, cheap) to reach.

Prefer the no-muss approach of a fund? Fidelity Select Natural Gas (FSNGX) invests in pure-play gas companies as well as diversified energy concerns with sizable natural-gas operations.

Invest in consumers ... focusing on companies that cater to wealthier households.

Last time: Retail stocks sank nearly 17% last summer when high fuel costs choked off consumer spending. No surprise there, since rising prices at the pump often force households to tighten their budgets. An average gallon of regular unleaded jumped $1 between April 2010 and April 2011, costing U.S. households more than $140 billion.

This time: Consumers are far better prepared to deal with rising prices. Since last spring the unemployment rate has dropped to 8.3%, from more than 9%. Meanwhile, household financial obligations keep shrinking. Thanks to low interest rates, households can service their debt with 10.9% of their disposable income, down from 14% in 2007.

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There's also the psychology to consider. Sure, $4 gas is disquieting, but it's no longer new. We've seen it twice before. And at today's prices, energy spending as a percentage of disposable income is 5.5%, down from more than 6% in 2008 and 8.1% in 1980.

Most critically: "Prices still aren't back to 2011 levels, and last year prices weren't as high as they were in 2008," says James Hamilton, an economist at the University of California at San Diego. "As long as you're retracing a prior run-up and not going above it, it doesn't have as much shock effect," he says.

Best strategy: Think Nordstrom (JWN, Fortune 500) and Coach (COH), not Wal-Mart. For all the fear that oil would knock out the consumer, retail shares have soared 19% this year. Higher-end retailers did especially well. While Wal-Mart is up 3%, the Dow Jones luxury index has soared 23%.

That's no accident, says Mark Luschini, chief investment strategist for Janney Montgomery Scott. "As the stock and housing markets have begun to recover, the net worth of affluent households has risen," he says. Poorer households relying mostly on wages are having a much tougher time, since fuel represents a greater percentage of their income.

There are no funds that focus only on high-end retailers. But iShares Dow Jones U.S. Consumer Goods (IYK) offers a mix of defensive and economically sensitive holdings from leisure goods firms (Nike) to automakers (Ford) to luxury sellers (Coach). The fund excludes pure retailers, so Wal-Mart is not in this portfolio.

Invest in emerging markets ... now that inflation is in check.

Last time: In 2011 the increase in oil contributed to -- and coincided with -- a sharp rise in other commodity prices. Corn, for instance, shot up 20% by the spring, while rice soared as much as 16% by late summer.

That, in turn, forced central banks in the emerging world to hike interest rates to keep a lid on inflation. The direct consequence, market strategists say, was that equity markets in China, Brazil, and India sank 20% to nearly 40%.

This time: Policymakers are cutting rates, not hiking them, as economies have started to slow. Growth in the developing world fell more than a percentage point to 6.2% last year and is expected to slip a bit more this year, the International Monetary Fund says.

Non-oil commodity costs are also down. "Food prices are well off their peak," notes Brian Rose, senior investment strategist for UBS. "Even with oil prices at this level, most emerging markets are seeing inflation falling."

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Starting next year, growth in the region is forecast to pick up again because of monetary easing, but not at a fast enough pace to reignite inflation. That expectation is already having a positive effect on share prices: So far this year, emerging markets stocks are up 14%, vs. a 10% rise in the developed world.

Best strategy: If emerging markets represent less than a quarter of your foreign-equity portfolio, boost that stake. These economies are still growing twice as fast as the developed world. And stocks there are trading at a price/earnings ratio of 10.5 based on projected profits, below their long-term average of 13.5, says Kevin O'Hare, co-manager of the Lazard Developing Markets Fund.

Should Mideast tensions boil over, and if crude goes to $150, these markets will likely diverge. "The countries that benefit most from oil prices going up: Russia and parts of Latin America," says Phil Langham, head of RBC Global Asset Management's emerging-markets team. Asian nations, by contrast, are oil importers, "so they would suffer," he says.

Trouble is, more than half of a typical developing-market fund is held in Asia. You can supplement a broad emerging-market stake -- while hedging against a bigger oil spike -- with a small bet on an ETF that invests narrowly, such as SPDR S&P Russia (RBL) and SPDR S&P Emerging Latin America (GML). Or go with a developing-world energy fund like EGShares Energy GEMS (OGEM); its biggest holdings include Gazprom and PetroChina, Russia's and China's top natural-gas producers.

Invest in classic growth ... favoring global industrial giants.

Last time: When growth slows, investors tend to gravitate toward sectors that are still expanding rapidly. When there's fear that growth will disappear entirely, though, panic usually sets in. That's what happened in 2011, when worries that the oil shock would cause a double-dip recession drove investors to the most defensive parts of the market, led by utility stocks.

This time: Rising prices today could put a dent in GDP expectations, but only a modest one. As a rule of thumb, every $10 rise in the cost of crude leads to about a 25¢-per-gallon bump in prices at the pump and a drop of roughly two-tenths of a percentage point in overall economic growth, according to economists at S&P.

Yet even though prices are up, Nigel Gault, chief U.S. economist at IHS Global Insight, is sticking with his forecast that domestic GDP will grow 2.1% this year, arguing that rising fuel costs have been "balanced by the stream of other good news, notably from the labor market and auto sales."

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American Century's Liss adds, even if U.S. economic growth were to slow this year, "that still doesn't mean recession." It means GDP growth slips from 2.1% to 1.9%.

No expectations of economic Armageddon "suggests a different investment strategy vs. last year," says James Paulsen, chief investment strategist at Wells Capital Management. He thinks businesses whose fortunes are closely tied to the ups and downs of the economy will fare best, and favors overlooked groups like industrials and basic materials. Both are up 11% so far this year, vs. tech's 21% rise, putting them among the cheapest growth sectors.

Best strategy: Focus on industrial stalwarts with a global reach, Paulsen says. A classic example: General Electric (GE, Fortune 500), whose emerging markets and energy businesses should benefit if the global economy accelerates. Meanwhile, its massive health care division serves as a hedge in case growth starts to slow.

Within materials, Christopher Beck, a portfolio manager with Delaware Investments, favors Albemarle (ALB), a specialty chemical company. Its chemicals are used by the petroleum industry to convert heavy crude into gas, so ALB will benefit if oil heats up. If the economy slows, the firm's health care line -- it's a major supplier of ibuprofen -- will prop up revenue. Prefer to invest via a fund? Check out Vanguard Industrials ETF (VIS), with big holdings in GE, United Technologies, and 3M.

What these companies share with other investments that stand to prosper in the months ahead: an ability to keep their gears of growth turning -- whichever way oil goes.

Additional reporting by Carolyn Bigda.

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