The market’s initial reaction to the news has been predictable: Sell oil and gas. Gas, of course, has been in a virtual free fall all year, but now black gold has broken below long-standing support of around USD70 a barrel. Already soft, Canadian oil and gas producer trusts have continued to give ground, despite a very strong second quarter earnings season that occurred amid fears lower prices would slow energy patch growth.

As I wrote last month, it’s long past the time to get skeptical about the Canadian trusts you own. Last month, we saw yet another dividend cut from the natural gas-focused producer group: Focus Energy Trust (FET.UN, FETUF). And at least half a dozen others are in danger of reductions by the end of the year. Even the strongest of the group are vulnerable to a drop in price, due to high valuations after unprecedented run-ups during the past several years.

I’m hardly in the bearish camp, however, when it comes to energy or any type of Canadian trust. For example, 11 of the 32 oil and gas producer trusts tracked in the How They Rate Table of Canadian Edge are still buys, though some are currently trading above their buy targets. As the Top 10 Portfolio section details, I’m also still quite bullish on the energy services sector, including battered Essential Energy Services (ESN.UN, EEYUF). Click below to get my full discussion on Essential Energy.

Even if the deepwater Gulf fields exceed their most optimistic projections, they won’t be anywhere close to the size of the declining mega-fields of Saudi Arabia or even Mexico. Moreover, it will be at least three to four years before they can begin to produce meaningful quantities of energy.

Finally, Chevron’s successful test hole went to a depth of 5.3 miles below the surface of the waves and was 175 miles from the nearest coastline. Obviously, it will take a great deal of strong management, skilled labor, time, patience, sophisticated technology and above all money to bring that oil and gas to market. And that won’t happen unless oil and gas prices remain at lofty levels.

Doubtless, greater reliance on energy resources outside the Middle East, West Africa or Venezuela should help smooth out at least some of the politically driven volatility in the energy market. But like Canada’s oil sands, the estimated 3 billion to 15 billion barrels of deepwater Gulf oil and gas aren't cheap enough to be truly conventional reserves in the sense the North Sea discovery of the 1970s represented. Instead, the expense of getting them out means that increased dependence on deepwater Gulf oil and gas for our daily needs will build an ever-rising floor under oil and gas prices.

Chevron’s deepwater Gulf discovery is having an impact on the near-term energy market and could wind up being the catalyst to bring down prices further in the near term. That’s certainly what Republican Washington would like to see coming into a very tough election year. And it’s very likely what the bigger players in the industry would prefer in order to discourage alternative energy and conservation as well as punitive measures by politicians. It’s also a fact that energy prices fell in the months before elections in 2004.

The deepwater discovery, however, has nothing close to the clout needed to end the bull market in energy that began back in the late '90s. Like the '70s bull, this one will only end when we’ve seen real changes in consumption habits, a genuine push to alternative energy like nuclear power on a mass scale, a real discovery of conventional reserves and very likely a demand-crushing global recession.

As of September 2006, we’ve yet to see any of these factors take shape. In fact, judging from the continued preponderance of gas guzzlers on the road, Americans still seem to be buying the idea that prices will come down without any change in lifestyle. That didn’t work in the '70s, and it won’t work this time around.

My outlook and strategy for Canadian royalty and income trusts remain the same as they’ve been for most of this year. Energy is the straw that stirs the drink, and a near-term dip in prices would almost surely bring down share prices of virtually all trusts, including those that have nothing to do with oil and gas. A sharp drop in energy prices would also likely hurt the Canadian dollar, thereby reducing the US dollar value of trusts’ share prices and dividends.

Dividends of trusts that aren’t involved with energy production, however, are more durable than those paid by producers, provided they’re backed by solid businesses. Low-cost, low-debt, low-payout ratio producer trusts with healthy reserve bases aren't particularly vulnerable to even a sharp near-term dip in energy prices. And there are more than a few trusts, which are cheap, that to date have been ignored by myopic yield-chasing investors.

When I first began writing Canadian Edge in summer 2004, my goal was to help investors make total returns of around 10 percent a year.

That was based on the idea of getting an average yield of 8 to 9 percent, along with a couple percentage points of capital gains as underlying businesses became more valuable and dividends were ratcheted up.

2005 and the second half of 2004, of course, produced much richer returns, with the average Canadian Edge Portfolio share gaining 30 percent-plus last year. So far this year, the S&P Toronto Stock Exchange Composite Index is up about 10 percent, not including dividends. Much of that gain came in the summer months, as interest rates moderated and gas prices stabilized. Some of the Top 10 and Super Yielding Portfolio picks have done better than that--some worse.

As we near the end of 2006, it’s time to consider once again what your goals are with the Canadian trusts in your portfolio and how realistic they are. If you’re shooting for 30 percent total returns every year, you may well get them by being extremely selective and not being afraid to buy when prices fall or sell when a trust’s share price gets too high.

My goal is always to maximize returns, and I’ll be doing my best to help readers do the same. Realistically, however, we all have a much better shot of making those kinds of gains if we’re patient enough to hold trusts with strong, growing businesses through their ups and downs. That may mean being satisfied with a return of less than 10 percent for a particular calendar year. And it may mean sitting in a pool of red ink until tough macro conditions sort themselves out.

At this point, the biggest risk to Canadian trusts’ returns for the rest of 2006 is a dramatic dip in oil and gas prices. The important thing to remember if that occurs is that all trusts’ share prices are likely to suffer, but those that continue to increase or even hold their dividends will swiftly recover whatever ground they lose.

Any dip in prices will be an opportunity to buy, not a reason to sell into panic.

The second key point to remember going forward is to adhere to my buy targets that are based on fundamentals. It may seem sometimes that a particular trust will never again trade below its buy target.

But time and again, we’ve seen even the most overextended recommendations come back into the bargain range.

Over time, trusts trend in tandem with their dividend growth. Those who chase them when they run ahead of dividend growth more often than not wind up underwater. Those who buy when prices trend below dividend growth realize the biggest profits.