The past couple of weeks have seen oil ETFs across the board break their 200 day moving averages, often touted as seriously tough points of resistance, with experts suggesting a bull market headed our way. The industry as a whole looks set for healthy growth, thanks in no small part to US oil companies, which leads us to ask if it’s worth investing in oil ETFs now, and which ones we should look at.
The dramatic increase in US oil production was one of 2012’s biggest stories in terms of commodities. The country will remain the fastest growing source of oil for 2013, but has eyes on the prize of being the world’s biggest producer of oil by the end of the decade. Saudi Arabia is currently in the top spot, and it will require considerable effort for the US to overtake them.
The balance is very delicate of course, with some analysts asserting that production can only weaken if the price of a barrel drops below $80.
Part of the reason ETFs look to be doing strongly is because not only have US oil companies increased production, their profits are way up too, particularly when it comes to those in the Midwest.
It’s clear from last year’s success, and the likely profitability of 2013, that oil ETFs focusing on the US markets should be the ones to go for. It looks like they’re going to do very well, and there doesn’t seem to be a better region to choose, especially with so many having broken moving averages recently. Be aware however, that there have been indicators that suggest some may be overbought.
With all of this in mind, the following three ETFs appear set for a good 2013:
United States Oil Fund (USO): This is one of the most popular commodity products to be found anywhere, and is widely traded. There are nearly 9 million shares traded in USO each day. Be aware that it invests in futures trading, but is an ideal candidate for the short term. If you’re going to be investing in the oil market, then this is usually the very first stop.
Market Vectors Unconventional Oil & Gas (FRAK): Fracking has gained some notoriety in the press recently, but it’s certainly on the increase. FRAK, as indicated by its name, track some of the more unconventional oil and gas companies that are using new methods. It’s a relatively new fund, but if experts are to be believed, it’s at the forefront of oil technology.
Energy Select Sector SPDR (XLE): This particular ETF is being backed to have a good 2013 because a good proportion of it consists of some of the United States’ largest oil companies including Exxon Mobil and Chevron. Production is on the increase, with few signs of slowing, and it seems as though their performance alone could carry this ETF. Exxon recently knocked Apple off the top spot for most valuable company in the world. There’s also a likely dividend of approximately 1.7 percent to look forward to.
Are ETFs the best way of speculating on the oil industry, and what makes them so effective?
There’s no doubt that speculation on oil prices is one of the world’s most popular methods of investment, and there are an incredible number of ways of doing it. If you’re new to the market, then you’re probably considering the best ways of profiting from the industry. The simple fact is, ETFs are the best way of getting a broad scope of the oil industry into your portfolio. You can simply trade crude oil prices alone, but this won’t necessarily account for a lot of other things, such as the performance of individual companies or refineries.
The Benefits of ETFs
As with a lot of other investment products, ETFs mean that you don’t actually have to own the underlying commodity; essential when we’re talking whole barrels of oil. The ETF that you choose could contain all manner of different oil related instruments, from oil company stocks to oil indexes. The USO (United States Oil) ETF for instance, is comprised of a great many instruments including futures and options.
The ability to invest in a portion of the oil industry as a whole is the primary attraction of ETFs. If you wanted to do this through other means, you’d have to search for and invest in a great number of areas, making things difficult to keep track of. An ETF, depending on the one you choose, means everything you need is contained within one package.
If you’re looking to compare ETFs with other methods of investment, then the main thing to think about it is the fact that ETFs are extremely tax efficient. This is because capital gains tax is not paid on the transactions when the fund meets an investor’s redemption. If you file taxes online there are some great software packages available to sort through the complexities of investment decisions.
Oil ETFs are often used as a way to hedge other investments. You could, for instance, sell an oil ETF in order to hedge your investments in a country which is heavily reliant upon a successful oil industry.
ETFs Are Not Always the Easy Option
Just as with every other product on the market, you absolutely have to do you research before making a decision. This is because all ETFs will perform differently. You might have a general idea about how the price of oil is currently performing, and know what position you want to take, but that doesn’t mean that every ETF will behave as you expect.
Some investors might think that an ETF is an easy way to diversify your portfolio within the oil industry, which is true to a certain extent, but you still need to make sure you understand the components of the fund, and are aware of how it behaves and what influences it. Failing to do so is like blindly investing in countless different areas.
While ETFs can be a low cost option, other products such as contracts for difference by CMC Markets are more accessible due to leverage, though they are high risk.
While the global financial markets have displayed considerable strength despite the growing economic tumult, it is only natural that they should continue to experience fluctuating fortunes and volatile conditions. This principle can be applied to a number of individual markets and financial instruments, each of which are directly impacted by wider economic events.
Crude oil prices have endured a particularly unstable 2012, as the eurozone crisis has taken hold and had a drastic impact on nations including Greece, Portugal, Italy, Spain and Ireland. The situation has hardly been helped by talk of the fiscal cliff in the U.S., which could force the federal government to implement widespread tax hikes and slash public spending by up to $600 billion from 2013.
Why Prices have Consolidated as December Approaches
Fortunately there has at least been some positive news in the crude oil market this week, as eurozone ministers and the International Monetary Fund (IMF) finally agreed a deal to financial additional loans to debt ridden Greece. While the estimated sum of 47 billion Euros will provide only temporary relief and falls some way short of the amount that Greek investors had called for, it does lay a foundation from which Greece can reduce their fiscal liability and approach a financially solvent future.
This has allayed growing concern in the financial markets, and allowed crude oil prices to stabilize in line with the global economy. As a consequence, Brent North Sea crude for delivery in January eased by 52 cents to $110.40 a barrel on the London Stock Exchange at the beginning of the week, while the West Texas Intermediate (WTI) exchange added nine U.S. cents to achieve a price of $87.83 per barrel. These price movements reflected a sudden surge in investor confidence, as both the U.S. Congress and eurozone ministers edged closer towards respective resolutions.
The Need for Caution: Why the Most Recent Greek Bail-Out Does not Guarantee Long Term Market Stability
The news of an additional Greek bail-out has also been supplemented by surprising statistics in the U.S., which suggested that the consumer confidence index rose from 73.1 to 73.7 and achieved its highest level since February, 2008. Despite the initial sentiment that greeted both of these announcements, however, the mood of investors has already began to dissipate. This is primarily due to the lack of definitive or authoritative economic projections for 2013, which continues to create instability and uncertainty within the financial markets.
As if to reaffirm this, the crude oil recovery and subsequent period of consolidation is already showing signs of stalling. After the initial wave of positivity among investors began to wane, the price of crude oil remained fixed at $88.23 per barrel as caution again emerged as the watchword for market participants. Although economist predict that sideways price movements are likely in the coming weeks, it is thought that only a break above $88.50 per barrel would dramatically improve the near-term outlook.
The fluctuation in crude oil prices has provided a fascinating insight into the current financial markets, and how vulnerable they are to wider economic circumstances. While positive developments in both the eurozone and the U.S. may improve market sentiment temporarily, the doubts surrounding the Greek economy and the capacity of warring U.S. Senators to strike an amicable budget agreement will linger until each issue is definitively resolved. With this in mind, price movements in the crude oil market and the foreign exchange arena (Forex, FX) are likely to experience further volatility at least until the first financial quarter of 2013.
Global demand for oil is set to rise in 2011 as the economic recovery continues to remain strong in developed nations, and emerging market economies continue to grow. In early 2011, economic data out of the United States has reassured investors that the recovery remains robust. Employment figures, in particular, continue to improve, albeit at a very modest pace, and Federal Reserve Chairman Ben Bernanke has referenced the improving labor conditions as proof that the economic recovery is continuing to gain solid traction.
Strong economic growth is also continuing in emerging market economies such as China, India, Brazil, and Russia. This consistent growth around the globe has led many investors to believe that commodity prices will continue to rise in 2011, specifically oil. One way an investor can expose his portfolio to a potential rise or fall in oil prices is to buy an exchange traded fund. In this article, we are going to conduct technical analysis of one such ETF—the Powershares DB Oil Fund (DBO).
DBO tracks the price of crude oil. Therefore, if the price of oil rises in 2011, then DBO will rise as well; conversely, if the price of oil falls in 2011, then DBO will likewise fall. Let’s take a look at a price chart.
The chart above is showing about 1 year of price data on DBO. As you can see, there was a sharp selloff in May of last year. Fundamentally, this sell off was directly related to the widespread panic that flooded financial markets in May 2010 as Greece was facing imminent sovereign default. Finally, in late May, early June, the European Central Bank and International Monetary Fund stepped in and committed bailout funds for Greece and other struggling EuroZone countries. This served to calm currency trading volatility and financial markets, and as you can see on the chart above, oil has risen nicely since its low at the end of May.
DBO has made a very nice trending move off its May lows up to its February HI’s. In fact, you can see the green circles that show very clear higher lows throughout the move, which is a classic sign of strong trending behavior. Now, however, DBO is at a major breaking point. As you can see, price is coming into the HI’s of las May up at 30. Price reached as high as 29.50 in the past few weeks before selling off lightly to the 28 level. Currently, the two price levels that are most important are the 27.50 level and the 29.50 level. These are the two prices that DBO is moving inside of.
If DBO can break above 29.50, then it has a major test of resistance at 30. If it tests support to the downside, price will find support at 27.50, 27.00, and then 26.25.
Since the global economy is set to grow in 2011, DBO will most likely retest the HI’s up at 30.00. The demand for energy in emerging markets, specifically China and India, could very well pull price above the 30.00 area during the second quarter of 2011.
ETF’s have been hugely popular in recent years and many investors are unaware of the potential pitfalls of many of them. There have been lots of controversy about the leveraged ETFs which deteriorate over time and can lead to huge portfolio losses. There are also issues with the accuracy of the tracking of certain ETF’s particularly those that seek to track the price of commodities by buying and selling futures. One such ETF is the United States Oil Fund (USO) which seeks to track the spot price of West Texas light sweet crude.
Taipan wrote up a nice piece explaining how the USO ETF can have a difficult time tracking the price of crude accurately due to the contango effect.
Contango is the phenomenon that futures further out in time are more expensive than futures expiring in the current month. Contango is typical in crude because it costs money to store, ship and insure oil and those costs are built into prices over time. Sometimes contango gets extremely steep, with $10+ dollars in difference within a year’s time.
If the futures prices are more expensive from month to month, the USO fund may experience what is called a “negative roll yield.”
Here is what it looks like (this is a small example; the USO trades tens of thousands of futures contracts each month):
You have 10 contracts of crude oil in October that you can sell for $80 – you net $800.
You MUST buy $800 worth of the next month’s contracts, which are trading at $85; this means you can only afford to buy 9 contracts (balance goes into cash, which is invested in short-term Treasuries, which are essentially yielding NOTHING now).
Now let’s assume that crude rallies $10 to $95 (you own 9 contracts at $85).
You would make $90 (9 contracts x $10), where the month before you would have made $100 on the same price advance.
This does also mean that you would lose less if it dropped, but if the USO continues to go higher and higher and the contango gets more steep (which happens quite a bit) you will NOT make the returns you may expect!
While the roll doesn’t make you “lose” money necessarily, it may slow the rate at which the USO responds to movements in the long term in crude oil — this is the key to this article.
Taking a look at the oil ETF tracking data, I see an interesting pairs trade setting up – go short oil stocks, but long the price of crude. This is a strategy that will likely benefit more should the market stumble up here because the price of oil stocks will undoubtedly move faster than crude. Let’s take a look at the data..
I know it’s hard to read. I had to squeeze it into the page, so it’s a bit distorted, but focus on one element of data in particular. The DI 15 and DI 30 scores are proprietary indicators of SelfInvestors.com that measure the amount of demand in a stock over 15 and 30 trading days. Demand is measured through price and volume so high volume moves up indicate high demand while high volume moves down indicate very low demand. Lower volume moves are more weighted less. Taking that into consideration I see very weak demand in shorting the price of crude oil (see ultra short crude oil ticker DTO) with DI scores of -10, 12. Now take a look at the oil ETF showing the greatest demand. That’s the Ultra Short Oil & Gas ETF (DUG) with DI scores of 3,3. So, if you want a decent trade with relatively less risk, you could short oil stocks and go long on the price of crude or if you’re feeling lucky, just short oil stocks.
You can get similar data for all oil ETFs on the home page here at Oil ETF Central
If you’re looking to trade options on oil stocks check out oil trade options.
It wasn’t too long ago that Interior Secretary Ken Salazar said that an extended moratorium of 6 months on deep water drilling was needed while the Feds reviewed and investigated. So, it’s not surprising that folks are up in arms that the agency issued a new offshore oil drilling permit to Bandon Oil & Gas today. Adding insult to injury, the permit was issued for a site about 50 miles off the coast of Louisiana.
So what’s the deal? Apparently, the restriction is for sites greater than 500 feet while the Bandon Oil site is 115 deep. However, as the New York Times reports, permits are still being issued because the moratorium only bans new drilling, not existing projects. There are a host of other issues that clearly indicate offshore drilling is still alive and well. It appears the government bark is more vicious than its bite and have misled the public on this issue.
Igor Kocis, CEO of Geothermal Anywhere in Slovakia, discusses the emerging UltraDrill technology in order to drill to greater depths, where the energy and heat is greater which is needed for electricity generation. In Slovakia, the technology isn’t yet there to extract geothermal energy in mass quantities for electricity generation. It’s the billion dollar question I suppose as companies are trying to figure out ways to cost effectively drill deeper and deeper. Reminds of another industry.. hmmm.. the oil industry perhaps?
The price of crude broke out to a new 52 week high last week and looks poised to test $100 in the coming weeks. The 82 – 84 level had been a tough level of resistance for several months, but this firm breakout means that this level of previous resistance now acts as support and a potential spring board on the way up to $100. I had written earlier about a potential triple top in crude oil, but that pattern has now failed with this breakout.
At $100/barrel, that really starts to wreak havoc on an already shaky economy, so it will be interesting if the overall market begins to price that in.
It’s time for another crude oil price update! After hitting resistance again around the $80 – 82 level, it’s come all the way back to the $70 level which is a critical level of support. It happens to be the 200 day moving average as well. If crude closes below the $70 level, it could set up a sustained move lower for some time. The $65 level would be a likely first target, but I’d expect a move close to $60 if the $70 level is breached.
Here’s a look at the chart