The impact of US$100 oil isn’t trickling down to the price of energy stocks, and that signals a hidden opportunity for investors, according to new CIBC World Markets report.

“The TSX oil and gas index should be trading about 35% above current levels,” estimates Jeff Rubin, chief strategist and chief economist at CIBC World Markets in his monthly Canadian Portfolio Strategy Outlook report. But instead, energy stock valuations appear to embed oil prices 25% below the US$100 per barrel price he expects oil to average over the rest of the year. “While the energy index tracked crude’s rise closely to US$75, it has priced in little of the increase since,” says Rubin.

Also contributing to the gap he sees in the index has been the low price of natural gas, which has in turn restrained valuations. But he doesn’t expect that to continue as gas-fired power generation plants take the place of cancelled coal-fired plants. “Surging utility demand will soon push North American natural gas prices into the double-digit range,” says Rubin.

These factors are bolstering Rubin’s view that the energy and materials-rich Toronto Stock Exchange is positioned to significantly outperform the U.S. market and offer greater diversification for investors.

“Since the beginning of the decade, TSX total returns have been 7% better than that of the S&P 500 per year,” says Rubin, adding that the continued outperformance seen in the first quarter should hold for the balance of the year and 2009.

“In a sharp reversal from the past, a dollar invested in the Canadian market now offers greater opportunity for diversification for investors with sizeable U.S. dollar exposure than a matching amount placed in European and Asian stocks,” Rubin says.

“Two-thirds of the TSX’s superior total return performance over the S&P 500 over last year was due to the outperformance of various Canadian sectors over their U.S. market counterparts. This is particularly true for energy and material stocks, which since the beginning of the year have played decisive roles in the better overall performance of the Canadian markets.”

Rubin’s model portfolio continues to be heavily overweight in these sectors. And this month, he is shifting more funds into energy. That increase is funded by a 1% cut in telecoms, where he remains underweight due to slowing revenue growth and a softer global M&A environment.

Rubin also remains overweight in the materials sector which has been the TSX’s leading performer in 2008.
He also believes gold’s recent retreat will prove temporary given a continuing weak greenback, inflationary jitters and further anticipated U.S. Federal Reserve rate cuts.

He remains overweight in bonds as well, expecting another 75 basis-point interest rate cut from the Bank of Canada and a 100 basis-point rate cut from the U.S. Federal Reserve Board. Rubin continues to be underweight cash in his portfolio.

He continues to hold an underweight stance in financials anticipating further asset write downs from the U.S. subprime mortgage market.

Rubin’s year-end target for the TSX is 14,500, and 16,200 for year-end 2009. This reflects his expectation that the TSX will continue to outperform the S&P 500 with returns of 7.7% this year and 14.1% in 2009.