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Energy Crash: Is It Time for Investors to Jump In?

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Anyone who has filled a gas tank knows the price of crude oil has steadily dropped since mid-2014.

It has yet to hit lows of 1998, near $11 per barrel for West Texas Intermediate crude, but breaking below $30 per barrel in January seemed to open the market’s Pandora’s Box: global equities markets swooned, and high-yield bonds, of which energy firms are big borrowers, staggered. The S&P/ISDA CDS US Energy Credit Default index soared, roiling an already beleaguered market.

There seems no light at the end of this pipeline with the crushing supply and lower global demand, but in contrarian market thought, this might be the time to get exposure. And as the commodity adage goes: There’s no cure for low oil prices like low oil prices.

Understanding the Drill

The Commodity Futures Trading Commission’s Commitment of Traders (COT) is a weekly report in which various segments of the commodity business must report positions in futures and options markets. The best use of the report is to review at least a six-month trend in market player movement. However, in a snapshot, the Feb. 2 report of WTI New York Mercantile Exchange positions shows Commercials, which are producers and merchants, were net short crude oil, but net buyers since the previous report. Managed money, or large speculators, were net long, but net sellers from the previous report. It seems the so-called “smart money,” ie. commercials, are cautious on the market, where as the other players believe the market will go higher.

Dennis Weinmann, principal at Coquest, an energy broker and investment firm based in Dallas, says the COT snapshot really doesn’t tell much, especially as it’s already a week old when it comes out. Perhaps a better indicator — he notes facetiously — is the mainstream media, like when’s recent lead story was about crude oil at 13-year lows. That, he told one colleague, must mean capitulation is near.

In a more serious vein, he says despite the depressed market, there are ways to take advantage of a near-bottom. He says that pipelines and other suppliers will come back sooner than the producers. “I have no idea if the bottom is $10 or $26, but we’re closer to a bottom than a top.” He says even if the market goes sideways for five years, there are companies still transporting goods, including oil. “It’s not like energy [oil] use is going away.” He says these companies aren’t necessarily a good buy due to dividends, but because their current prices are depressed. He also points out that the shale boom and bust was largely on the backs of regional banks, which are being most affected with outstanding loans. Further, bankruptcies by some producers or even banks could be bullish for prices because it means private equity will move in and it’s doubtful they’ll be covering their positions because crude oil prices are so low. That means a market full of buyers.

Dan Dicker, trader and prognosticator on various business shows and blogs, says to watch the depth of the market’s contango, which is when a futures contract’s back months are selling at a higher price to the front month, and the normal curve of the market due to basic storage costs of commodities. Dicker notes a weak contango is a “sure sign of a very bullish market.” Further out that spread seems to be flattening, Weinmann says, which could be a sign of a turning market.

But how to get exposure without buying the crude? Of course an investor can buy specific energy-related stocks to gain exposure, but that can be tricky, especially when a bottom might not be in. Other ways are investing in hedge funds or commodity trading advisors that focus on the energy markets, such as the Cogent Energy Investment Management Commodity Strategy fund, which has a compounded annual return of 18% since it started in 2013.

Perhaps an easier way to gain exposure is through energy-linked ETFs, which can be made up of energy-related stocks, the energy complex through futures and options, such as the United States Oil ETF (USO), or even those that focus on a single part of the complex or an index, such as the Canadian Crude Index ETF (CCX).

“Picking the low” has left behind a graveyard of traders who thought they knew a market. So crude oil prices, especially with current global fundamentals, ie. flush supply with lower demand, could continue to fall. But throughout commodity history, capitulation is the time to buy. At least with prices this low, it might be time to get some potential upward exposure.

— Check out Oil’s Rebound and Other Wrong-Way Forecasts by Barry Ritholtz on ThinkAdvisor.


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