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2015 Investor’s Guide: Don’t buy this, buy that—Energy and Mining

Sometimes the smartest actions are the ones you don’t take. That old dictum seems relevant at a moment when the markets are a paradox: Each new high only makes many veteran investors more nervous that disaster looms. Between lofty valuations, slowdowns from Europe to China, conflict from Ukraine to Syria, the end of the Fed’s bond-buying binge, and more, there are many reasons for caution. That’s why this year we decided to recommend not only investments to make but also ones to avoid. Smart defense is always wise, and the good news is that even in these precarious times, there are still opportunities to be found.

DON’T BUY OIL REFINERS
After the price of oil plummeted 30% in recent months—as American shale fields continue to pump out huge quantities—prospects are shaky for energy companies. Refiners rise and fall on a different cycle from producers—refiners can benefit from cheap petroleum—but Federated Investors portfolio manager Lawrence ­Auriana is avoiding them anyway, because of their unpredictability. “We shy away from refiners because it’s a very volatile business,” he says, “and it’s not really a growth business at the present time.”

DO BUY EXPLORATION AND PRODUCTION AND INTEGRATED OIL COMPANIES
Energy is now the cheapest sector in the S&P 500, and several pros are buying shares of oil producers that can smartly plumb their investments in U.S. shale. “People are still driving cars, still flying airplanes, and as the global economy comes back, you’ll see a recovery in energy stocks,” says Oppenheimer’s chief market strategist John Stoltzfus, who is scooping up shares of integrated oil companies like ConocoPhillips (cop) and Chevron (cvx). Auriana owns stock in Pioneer Natural Resources (pxd), which has wells in the Permian Basin, “where the geology is so good that the company can generate substantial return on investment even with oil at $60 a barrel.” And Intrepid Capital CEO Mark Travis gushes about Northern Oil & Gas (nog), a firm in North Dakota’s Bakken Shale that has locked in $90-per-barrel oil prices—even as the market price is in the 70s—through mid-2016 and still trades at a forward P/E of just 11.2. “When the market throws the baby out with the bath water, they don’t ask who’s hedged,” Travis says.

DON’T BUY METALS
With a bull market in equities heading toward its seventh year, gold is hovering below $1,200 an ounce—down from its 2011 peak of $1,900—and investors say it’s still searching for a bottom. Declining demand in China has also lowered prices for industrial metals like silver and copper.

DO BUY OVERSOLD MINING STOCKS
The falling price of gold has tarnished mining stocks. But bottom-feeding value investors see glimmers amid the gloom. “We continue to like gold-mining stocks because of their extremely low expectations,” says Wasif Latif, who helps oversee $66 billion as head of global multi-assets at USAA. His funds own shares of Goldcorp (gg), Eldorado Gold (ego), and Silver Wheaton (slw). “The companies can derive a better return than the commodity itself over time.” Michael ­Cuggino, who oversees the $7 billion multi-asset Permanent Portfolio Fund, holds industrial metal miners and natural-resource companies such as BHP Billiton (bhp) and Rio Tinto (rio), which are trading at P/Es of 12.5 and 9.5, respectively. “They’re the raw materials of economic production,” he says. Cuggino thinks shares of mining company Freeport-McMoRan (fcx) will rise since it “can make free cash off of $3 copper and still pay a dividend.” (The stock is yielding 4.3% and has a 13.9 P/E.) Intrepid’s Travis sees value in Vancouver-based Pan American Silver (paas), which has been losing money recently but maintains a 4.7% dividend yield. “You have to kind of make some ­assumptions about gold and silver, but I think you’re paid to wait,” Travis says. Jay Bowen, whose firm Bowen Hanes & Co. manages $2.7 billion, has found a way to play the flip side of inexpensive commodities: Leggett & Platt (leg), a leading manufacturer of bedsprings and other furniture components, for whom scrap metal and petroleum are major input costs.

DO BUY ENERGY MASTER LIMITED PARTNERSHIPS
Master limited partnerships have seen their values sink along with the price of oil, but the MLPs that consist of pipeline operators and service operations tend to stay busy no matter the price of West Texas crude—as long as people continue to use it. The profits of those MLPs are tied to demand, says Phil Blancato, president of Ladenburg Thalmann Asset Management, which manages $2 billion, and he expects U.S. demand to rise. “Cities are bigger,” he says. “We need more energy.” Blancato predicts a 30% to 40% increase in the need for oil and gas over the next 10 to 15 years, which means burgeoning profits at a moment when MLP valuations have dropped nearly 20% over a period of months. “That energy has to move through a pipe. I want to capitalize,” he says. Blancato recommends the Eagle MLP Strategy Fund, which has relatively high fees but has outperformed the Alerian MLP index since its inception in October 2012.

DO BUY RUSSIAN ENERGY COMPANIES
Ben Inker, co-head of asset allocation at GMO, which manages $120 billion, disagrees with the consensus view. He sees money to be made in Russian energy stocks, whose valuations have withered in the political frost caused by the conflict over Ukraine. “In our view pricing is everything,” he says. “There aren’t bad assets. There are bad prices of those assets.” Inker wouldn’t offer specific recommendations. But if you have a tolerance for risk, consider putting a few pennies in Gazprom (ogzpy), the world’s largest extractor of natural gas. It’s shivering at a ludicrously shrunken multiple of 3. Even a slight political thaw could send the stock upward.

Read more from the Fortune 2015 Investor’s Guide “Don’t Buy This, Buy That” series:

Consumer Stocks
Stocks, Bonds and Funds
Real Estate and Industrial Stocks
Foreign Markets
Technology and Biotech Stocks

This story is from the December 22, 2014 issue of Fortune.

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