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SECTOR SPOTLIGHT: Oil and Natural Gas

Oil prices have been in a down cycle, stemming from slowed global economies, lower demand, and a 53% increase in U.S. oil output. The International Energy Agency estimates that the global oil market will remain oversupplied during the first half of 2015. A more balanced market and recovery is expected for the second half of the year and lead to an increase in prices. Keys to a balanced oil market are a substantial reduction in U.S. oil drilling, flat-to-lower non-OPEC international production, and, perhaps most importantly, increased oil demand resulting from lower oil prices. In response to an improved supply/demand balance, prices are expected to gradually rise through 2015.

Oil prices are expected to equilibrate at about $70 per barrel in 2016. This should incent U.S. oil producers to maintain or modestly increase output, but avoid the growth levels of 2012 to 2014. The most negative influence on the oil industry recovery is inelastic global demand. Other potential headwinds include record-high U.S. inventories, the current high value of the U.S. dollar (which could incent non-U.S. producers to maximize production), and lifting of sanctions on Iranian oil exports should a nuclear deal be struck with the U.S.

Natural gas prices are also in a down cycle, primarily stemming from accelerated U.S. production growth in 2014 and warmer than normal weather this past winter. Year-to-date plus current futures prices for natural gas project a 2015 average price of $2.90 per million BTU, significantly less than the 2010 to 2014 average of $3.86. Natural gas prices have been weak for reasons simiar to lower oil prices – increased U.S. production and the warmer than normal weather last winter. Production growth was +18% during 2011 to 2014, with +11% growth in 2014. The prolific Marcellus shale formation in the U.S. northeast more than accounted for all of the production growth. Low natural gas prices have prompted the U.S. gas rig count to decline 38% since last fall’s peak. It is now at its lowest level since records began in 1987. This, along with reduced gas supplies associated with production from oil wells, sets the stage for a more balanced market in the last half of 2015. Weather will play a prominent role in setting gas prices in both summer and winter. We project prices will average $3.25 and $3.75 per million BTU in 2015 and 2016, respectively.

Current Sit Mutual Funds equity portfolios are either underweight or have neutral weights in the energy sector relative to benchmarks. Domestic portfolios overweight the refiners because they benefit from strong refining margins and the likelihood of a re-widening of the spread between Brent (international oil benchmark) oil prices and U.S. crudes. Refiners buy the cheaper U.S. crudes and sell refined products at their higher international prices. The refiners also benefit from an ongoing revaluation of their shares, as they capture the valuation premium of their captive master limited partnerships (MLP) relative to their own shares by dropping down logistics and other assets into the MLPs. In larger cap portfolios, the defensive integrated oils have been de-emphasized in favor of high-growth, high-quality exploration and production companies whose shares should benefit as oil and gas prices recover. Oilfield services providers have also been de-emphasized as their customers, the integrated oils and exploration and production companies, severely trim their capital expenditures in the wake of lower oil and gas prices. The oilfield services companies suffer further from acute price and margin erosion,which could persist well after an oil price recovery because of excess capacity of their products and services.

Manage Risk With Asset Allocation

Asset allocation is a very important part of risk management within an investment portfolio. By investing in multiple asset classes, such as stocks, bonds, real estate, etc., that do not have closely correlated returns, investors can lower the variability of the returns that their portfolio experience over time. After an allocation method has been selected, periodically rebalancing the portfolio becomes an integral component to this process.

Through different allocation and diversification strategies, it may be possible to create portfolios with reduced risk (as measured by return variability) that can produce more consistent returns. For example, the S&P 500® Index, which is often used as a proxy for U.S. large cap stocks, fluctuated in annual returns from a low of -37.00% (2008) to a high of 26.47% (2009) for the five years ended December 31, 2012, while the Barclays U.S. Aggregate Bond Index, a proxy for the U.S. taxable bond market, only fluctuated between +4.22% (2012) and +7.84% (2011) over the same time period. During the calendar year of 2008, a portfolio comprised of holdings from both indices would have experienced a smaller decline than one made up entirely of the S&P 500 Index. In 2012, investing only in bonds (as defined by the Barclays U.S. Aggregate Bond Index) would have produced a positive return of 4.22%, but adding stocks to the equation would have increased the return on a portfolio for that year.

Asset Allocation

Read the full article "Manage Risk With Asset Allocations".

July 1, 2015

The Sit Mutual Funds are managed by Sit Investment Associates, Inc., which has been operating under the highest ethical and professional standards since it was founded in 1981 by Eugene C. Sit. We maintain an uncompromising commitment and adherence to our investment philosophy and style, while continually seeking ways to enhance our investment process.

Eugene Sit

Read about Sit Investment Associates & Sit Mutual Funds founder Eugene Sit.

Fourth of July Holiday

Sit Mutual Funds and the New York Stock Exchange will be closed Friday, July 3rd in observance of Independence Day. Transactions received after 3 p.m. Central Time on July 2nd, will be processed on July 6th due to the holiday. Sit investor services representatives will resume taking calls on Monday, July 6th at 7:30 a.m., Central Time.

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