Thoughts On The Incongruous Energy Sector
David Fabian | Jan 23, 2015 06:33AM ET
The topic of energy stocks and crude oil prices has reached epic proportions on social media and financial news outlets. I have seen a myriad of “experts” pointing to oil prices plunging as low as $23 per barrel to as high as $80, by the middle of this year.
No matter where you fall on that spectrum, the one thing I know for certain is that no one knows what is going to happen to crude oil prices. The best forecasters in the world have no better idea than you or I where this trend will ultimately turn. Commodities can find themselves oversold and stay oversold for extended periods of time despite cyclical or economic factors that favor a reversal.
I am not interested in picking a bottom in the United States Oil Fund (NYSE:USO) or United States Natural Gas Fund (ARCA:UNG), but rather am focusing my efforts on the technical price patterns of energy stocks.
In my opinion, the investment opportunities in oil-related stocks follow far more predictable patterns than the direct commodity futures themselves.
The benchmark Energy Select Sector SPDR (ARCA:XLE) appears to be setting up what could be a potential floor in the energy arena. This ETF has nearly $12 billion invested in 45 large-cap energy producers and has continued to attract positive fund flows despite its hearty drop over the last seven months.
A look at the chart below shows how XLE hit a low in December and subsequently re-tested that level in the early stages of January. The eerily similar lows it hit on both occasions have the makings of a double bottom in energy stocks if this most recent strength can hold. Even some modest consolidation without a violation of those levels would ultimately be a good thing moving forward.
Those that have been waiting for some positive news from the energy sector should be buoyed by these observations. While it may be early to make a definitive call that the bottom is in, we are starting to see diverging qualities that favor strengthening in oil-related companies.
The biggest hurdle that fresh capital in XLE, or a related fund such as the Vanguard Energy ETF (NYSE:VDE), will face is the uptick in volatility compared to other areas of the market. Energy stocks have seen their daily price fluctuations magnified by two or three times what the broader market has been experiencing. Conservative investors should be wary of this risk before making a commitment with new money.
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Many of my income clients have also been inquiring as to the best area of the dividend-paying energy sector to supplement with high yield master limited partnerships (MLPs). My response has been to check out the iShares MSCI Global Energy Producers ETF (NYSE:FILL), which targets exposure to large integrated oil companies.
The top stocks in FILL include Exxon Mobil, Chevron Corp and Royal Dutch Shell A (BA:RDS). Note that this ETF has 47% of its 213 underlying stocks in countries outside the United States.
This ETF has a relatively small asset base of just $14 million, but has a liquid basket of holdings and has begun to accumulate more meaningful daily trading volume. From an income standpoint, FILL has an attractive 30-day SEC yield of 3.17% compared to 2.54% in XLE.
The energy sector has certainly captured the attention of market participants and should remain on your radar through the next several months. If we can build on the recent strength or hold current levels, this may turn into a more favorable long-term opportunity from a relative value standpoint.
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