With the dramatic rise (and fall) in crude oil prices these past several years, just like gold, many investors are looking to profit from these price movements, mainly through the use of oil ETFs, energy ETFs, and other popular investment vehicles such as oil futures.
Investing in Oil vs. Gold
Gold and oil do have some similarities: They are both commodities priced in USD, they are both recognized as significant to our global economy, and there is a finite amount of each resource available on this earth. Beyond that however, there really isn’t much else as far as similarities go. Oil really isn’t “black gold” as it’s often coined and infact reacts very differently to market conditions. Gold and oil indexes do not follow one another in the markets and will often end up going in opposite directions depending on global events. Many investors are often surprised by this but they shouldn’t be. Why? Because gold is money, a global currency, one that serves as a safe haven from government mismanagement, whereas oil is just a commodity.
Now there are a variety of factors that affect either of these commodities but generally with oil, oil supply and the global economy have the most significant impacts on its current price. In simple terms, a tight supply with a booming economy should normally equate to a rise in price.
Where Are Oil Prices Headed?
No question about it, oil in general has risen significantly over the years though it has receded somewhat due to a threatened global economy. It certainly hasn’t been a straight ride up in price – in fact looking at a 5-year oil chart shows many peaks and valleys but the point is we will likely never again see $40USD oil again. Why? Supply mainly. The peak in global oil production (i.e. peak oil) is soon coming and some believe is already upon us. Presently the economy is looking pretty grim at the moment which is having a significant dampening affect on oil prices but as the economy starts to recover I expect the oil price to shoot up again past even it’s current high. In other words, oil is only going to get more expensive; it’s just a matter of time.
Best Oil ETF
As my post title eluded to, I believe the best oil ETF is actually an energy ETF (more on that later) however if you’re looking for purely an oil fund there are are couple you should consider. Like other types of ETF’s, Oil ETFs come in a variety of flavors but really there are two basic types: crude oil ETFs and oil stock ETFs.
The most noteworthy crude oil ETF is probably the United State Oil Fund (USO) which trades around 10 million units per day and possesses $2 billion in assets. If you’re only interested in trading the commodity, this is probably your best bet but I caution you that because of the ongoing issue of contango, only short-term trades should be considered.
Another strong contender for the best oil ETF pick is the SPDR S&P Oil & Gas Exploration & Production ETF (XOP). This oil stock ETF seeks to track the performance of the S&P Oil & Gas Exploration & Production Select Industry Index and has a very low expense ratio of 0.35%. It is also very liquid with an average trading volume of 10 million shares.
Leveraged Oil ETFs
Similar to gold ETFs, there are leveraged oil ETFs that allow an investor to either short (bet on oil going down), double short or go double long on their investment. Please note however that due to the arithmetic of daily compounding, holding leveraged funds of any kind will eventually annihilate your portfolio over the long term. Thus, leveraged ETFs should only really be considered for very short term holds (i.e. 1 trading day)
Short Oil ETFs (-1x)
A short oil ETF allows an investor to profit from the price of oil going down. A few of the most popular ETFs include:
DDG – The ProShares Short Oil & Gas ETF shares correspond to the inverse (opposite) of the daily performance of the Dow Jones U.S. Oil & Gas Index.
SZO – The PowerShares DB Crude Oil Short ETN is based on a return version of the Deutsche Bank Liquid Commodity Index-Oil which seeks to inversely follow the underlying futures contracts from a basket of oil future contracts.
Double Short Oil ETFs (-2x)
A double short oil ETF allows the investor to profit from oil price declines, only doubly so.
SCO – The ProShares UltraShort DJ-UBS Crude Oil is a double short Oil ETF which seeks daily results that correspond to twice (200%) the inverse of the daily performance of The Dow Jones UBS Crude Oil Subindex.
DTO – The PowerShares DB Crude Oil Double Short ETN is based on a total return version of the Deutsche Bank Liquid Commodity Index-Oil, which seeks to achieve a double inverse result of the underlying futures contracts from a basket of oil future contracts.
Double Oil ETFs (2x)
A double oil ETF enables an investor to leverage themselves to gain double the effective return of a rise in oil prices.
UCO – ProShares Ultra DJ-UBS Crude Oil ETF seeks daily investment results that correspond to twice (200%) the daily performance of the Dow Jones UBS Crude Oil Subindex.
FOL – FactorShares 2X Oil Bull/S&P500 Bear is a fairly new double oil ETF that seeks to track approximately +200% of the daily return of the S&P Crude Oil – Equity Spread Total Return Index.
Why I Prefer an Energy ETF (Long Term)
Now as popular as crude oil ETFs are and as promising as future oil prices look, over the long run oil ETFs are not favorable in my opinion. Firstly, these ETFs are not all that effective in tracking the prices of the crude oil all that well. The main reason for this is that these ETFs invest primarily in oil futures making them especially susceptible to pricing anomalies in the oil futures markets. On top of that, the effects of contango has over time, disabled the oil ETF from fully keeping up with crude oil prices. Contango is essentially a market condition where commodity prices are typically higher on long term futures versus short-term futures contracts.
Another issue with Oil ETFs over the longer term is that they, well, track crude oil, and only oil. What’s wrong with that you say? Nothing really, for now anyway, but the longer the time frame, the more it is evident that oil is not a sustainable energy source. There is a finite amount of it in the ground and once that’s gone, well that’s it. I’m not necessarily saying this will happen in the near future but we are already near or at peak oil so it’s probably not as far off as you might think.
As such, I much prefer an energy ETF. A good energy stock ETF will not only contain oil stocks but a group of alternative energy stocks and commodities such as natural gas, solar energy, nuclear energy, wind energy, hydro power, and geothermal energy. These types of energy along with other power sources we have not yet even discovered are the future, not oil. So if you want a long term hold in this sector, select a top energy ETF and hold it. Some of the best energy ETFs I can recommend include:
IXC – iShares S&P Global Energy Sector Index Fund is an energy ETF fund that seeks to follow the performance of the Standard & Poor’s energy sector represented by the S&P Global 1200 Energy Sector Index.
XLE – Energy Select Sector SPDR Fund seeks to match the returns of the Energy Select Sector Index (index ticker: IXE). The expense ratio is a mere 0.20%
XEG:TSX – The iShares CDN Energy Sector Index Fund is a Canadian Oil/Energy ETF traded on the Toronto Stock Exchange that seeks to track the S&P/TSX Capped Energy Index. Personally I love Canadian ETFs and if you’re trading in CDN currency already, there’s little reason not to own this one.
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