The outlook for economic growth continues to improve, which should be a positive indicator for energy prices. Nonetheless, some prognosticators are still forecasting a double dip, so how can cautious clients get energy-exposure in their portfolios that will profit in either scenario?
Tom Lydon, editor and publisher of ETF Trends and president of investment advisory firm Global Trends Investments, points to several factors investors should consider:
- A weak dollar, rising equities and positive manufacturing data turn oil futures higher
- U.S. oil inventories are at their highest in 70 years for this time of year but this hasn’t weighed on prices
- A rise in oil demand is needed to reduce a glut that developed during the economic downturn
- Rising manufacturing in China could increase oil demand
Here’s his advice for energy ETFs that could do well in a slowing economy:
Energy Select Sector SPDR (XLE)
For investors uncomfortable with owning futures-based commodity ETFs, XLE can give exposure to oil prices and reap the benefits of higher profit margins for these corporations and sit out much of oil’s volatility.
XLE holds many of the major energy names: Exxon Mobil, Occidental, Chevron, and ConocoPhillips. Many oil companies have reported strong third-quarter earnings, so these companies are well-positioned to weather slowdowns in the short-term.
United States 12-Month Oil (USL)
Contango (when the futures price is higher than the spot price) has often dogged funds that only invest in the front-month futures contract because they lose money when contracts are rolled. USL mitigates the negative effect of contango by investing across all 12 months of the futures curve.
Since contango is the normal state of being for commodity markets, this fund may be a better way to get exposure to oil prices.
Guggenheim Solar (TAN)
If oil prices drop as a result of lower demand in the United States, it could put alternative energy strongly back in favor. Solar power has gotten a nice boost in recent months, thanks to initiatives in China and a push to incorporate more of it in the United States.
TAN is the larger and more liquid of the two solar ETFs – the other is Market Vectors Solar (KWT).
Michael Johnston, a senior analyst with ETF-research firm ETFdb, suggests that investors consider energy companies that trade as master limited partnerships.
MLPs are the companies that transport and store energy commodities, he says. “They’re not necessarily sensitive to big jumps in prices because their revenues aren’t necessarily going to go up or down if crude prices soar or plummet,” says Johnston.
His recommendation: the Alerian MLP ETF (AMLP) that invests in multiple MLP-companies.
Much of the demand for energy commodities is coming from emerging markets, Johnston notes, and that condition creates a potential market-neutral play.
An investor could go long EEO, the Emerging Markets Energy ETF and short XLE, the energy SPDR.
With that approach, he says, “You’re somewhat hedged against the energy market in general but taking a view that emerging markets is where the real growth lies and that’s going to perform better than the domestic energy market.”