Looking at the headlines regarding oil prices, it seems like the market has absolutely no hope. But hey, for investors with a strong stomach, this could be the opportunity you’ve been waiting for.
As Warren Buffett once said: “Be fearful when others are greedy and greedy when others are fearful.”
Now granted, there are certainly many reasons for the plunge in oil prices, which have recently hit levels not seen since 2009.
Just some include the policy of OPEC to flood the global markets with crude oil, the slowing of the global economy (especially in China) and the rise of the U.S. dollar (oil prices are denominated in USD).
Yet there some top-notch investors who think now is the time to take a position. One is Andrew Hall, who runs a top hedge fund and also is known as the “oil God.” He not only believes oil is poised for an upward move, but is also convinced that there’s not even an oversupply of crude oil on global markets.
OK, so how should investors play this? Well, for investors, a good way is to use exchange-traded funds, which generally provide a low-cost, diversified way to get exposure.
Let’s take a look at three options:
Play the Rebound in Crude Oil Prices: United States Oil Fund ETF (USO)
Expense Ratio: 0.45%
For the most part, investors use futures contracts to play the swings in oil prices, whether on the long or short side.
These instruments involve substantial leverage, which means that even a small move can generate notable returns. Yet, futures contracts are really for those investors who are professionals and have the time to monitor their investments.
This is why an ETF, such as the United States Oil Fund ETF (USO), can be a good option.
USO uses complex systems to track the Nymex futures contracts on WTI crude oil and there are about $3 billion in assets. In fact, because of the scale, USO has a reasonable management fee of 0.45%. The trading volume is also hefty, at a daily average of nearly 28 million.
Now it’s important to keep in mind that futures-driven ETFs do have a major drawback with the structure. In other words, a fund might have to pay more for futures contracts when there are big swings in prices, resulting in muted returns that don’t precisely track the movements in oil prices, especially over the longer term.
Although, if there is a strong rebound in oil prices, this impact is still likely to be minimal.
Play the Rebound in Crude Oil Prices: Energy SPDR (XLE)
Expense Ratio: 0.14%
If the futures markets seems kind of risky and … well, scary, then you may want to take a more conservative approach, such as by looking at an ETF that focuses on larger companies in the energy sector. And a good choice is the Energy SPDR (XLE).
The fund certainly has lots of scale, with over $61 billion in assets. This is a key reason why the expense ratio is so low.
The XLE tracks a market-cap weighted index of U.S. energy companies that are listed on the S&P 500. The fund represents all the key sectors like exploration & production, and distribution and services for crude oil and natural gas. Top holdings include many household names, such as Exxon Mobil (XOM), Chevron (CVX) and ConocoPhillips (COP). XLE also heavily leans toward large-caps, with an average market cap of $55.5 billion for fund holdings.
And the blue-chip nature of the fund produces an attractive 3.2% dividend yield.
Play the Rebound in Crude Oil Prices: Market Vectors Unconventional Oil & Gas ETF (FRAK)
Expense Ratio: 0.54%
Not long ago, the unconventional players in the energy market — such as those that used fracking — were the darlings.
Interestingly enough, they seemed more like cool startups. And yes, investors made lots of money.
But of course, the plunge in oil prices has been a nightmare. For example, the Market Vectors Unconventional Oil & Gas ETF (FRAK) fund is off a grueling 35% for the year so far.
Although, if there is a rebound in the oil prices, the unconventional operators should benefit greatly.
Many are relatively smaller firms, and that means there is more potential for stronger gains in revenues and earnings. Besides, these types of companies have businesses focused primarily on the production of oil, not related sectors like refining and retail.
Now, as for the FRAK ETF, you get the benefit of exposure to a group of leading firms. Consider that the average market cap in the portfolio is roughly $12.8 billion. And some of the top holdings include firms like EOG Resources (EOG), Apache (APA) and Pioneer Natural Resources (PXD).
The fund also has a decent dividend yield of 2.1%. But then again, this is a secondary benefit, as the main goal is to generate nice capital gains when the oil market gets back on track again.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.