The Best Oil ETFs to Buy as Crude Prices Recover

Plus: What is an ETF anyway?

Oil prices have come a long way from negative-$37 a barrel. Just two months removed from West Texas Intermediate crude oil futures going negative for the first time in history (the May contract), oil prices are back above $40 a barrel for the first time since before the pandemic. Meanwhile, energy stocks, in the dumps after months of losses and with no more sellers left, have gotten off their knees. But individual energy stocks still seem a tad unpredictable. Oil ETFs are a more efficient way to play the nascent rebound.

As we so often say here at Cabot Wealth Network, we’re stock pickers. We prefer to recommend individual stocks—growth stocksvalue stockssmall-cap stocks, etc. However, there are occasions when we recommend exchange-traded funds (ETFs). One of those occasions is when there’s a red-hot or rebounding sector and you want to take full advantage of its momentum. Rather than pick one or two stocks, it can make sense to buy an ETF that tracks a whole basket of stocks in that sector.

That’s why oil ETFs are a good option at the moment. Here are three that have shown particular strength as oil prices have rebounded.

Oil ETFs: iShares U.S. Oil & Gas Exploration & Production ETF (IEO)

As the name suggests, this ETF holds oil and gas companies specifically focused on exploration and production. It counts ConocoPhillips (COP)Marathon Petroleum (MPC) and EOG Resources (EOG) among its 10 largest holdings (out of 100). Right now, the IEO is the dog’s dinner – down 41% year to date. However, when oil prices were on the rise from 2016-2018, it rose 79%. And the fund has already risen nearly 70% from its March 18 low, actually pushing above its 50-day moving average for the first time since January. When oil prices get going again, the IEO could rise much higher.

Oil ETFs: Energy Select Sector SPDR Fund (XLE) 

The XLE is essentially a proxy for energy stocks as a group, with holdings that include all of the biggest names in the sector (Exxon (XOM), Chevron (CVX), Phillips 66 (PSX), Schlumberger (SLB), etc.), the 10 largest of which account for roughly 80%of the fund’s total assets. As big oil stocks go, so goes the XLE. And with the group staging a mini-rally since WTI prices went negative, the fund is up more than 15% since the beginning of last week, and 61% since the March 23 market bottom.

If you believe that oil prices will bounce back – and I’ll submit that there’s not much further for prices to fall once they’ve gone negative – then the XLE is a simple, sector-mimicking way to play it.

Oil ETFs: PowerShares DB Oil Fund (DBO)

This one’s a bit more niche, but it’s based on the value of crude oil futures contracts, which is where the DBO invests 100% of its assets. When oil prices rise, this fund rises even faster. From January 2016 through October 2018, the DBO more than doubled in price. It’s down 50% year to date, and unlike the other two oil ETFs on this list, the DBO has yet to get off its knees, trading near its 52-week lows, as oil futures contracts remain under water. When that changes, expect this fund to take off, even more so than the other two.

Bottom line: The worst of the energy sell-off is likely over, as it’s mathematically impossible for oil prices to go any lower, though it is possible that West Texas crude’s June futures contracts could go negative like May’s.

Energy stocks have responded surprisingly well, as investors immediately shook off the reverse sticker shock of seeing negative oil prices. If the rally continues, there’s lots of money to be made in these three oil ETFs.

So, What is an ETF Anyway?

Our primary focus is stocks. But exchange-traded funds—more commonly known by their abbreviation, ETFs—can also be an efficient, profitable place to invest your money.

An ETF is an investment fund that trades on a public stock exchange just like a stock. But unlike individual stocks, ETFs hold dozens and even hundreds of stocks, commodities or bonds, so you get the safety of diversification. In that way, they’re like mutual funds.

Because they are “unmanaged,” however—you might say they run on autopilot—ETFs entail lower annual fees than comparable index-based mutual funds, and far lower fees than actively managed mutual funds. And unlike mutual funds, which are priced once a day after the market closes, ETFs are traded throughout the day just like regular stocks, so you can buy or sell them whenever you want, and when you buy, you get exactly the price quoted when you buy.

Now, of the more than 1,750 U.S. ETFs available, many are designed to mimic the performance of major indexes. You can buy indexes that duplicate the performance of the S&P 500 and the Dow Industrials. You can also buy indexes that mimic lesser-known indexes like the S&P Emerging Markets Small Cap Index and the Dow Jones Small Cap Value Index.

Those are fine for investors who are content to just do as well as the averages.

But if you want to beat the averages, you’ve got to specialize. And for that, you need sector ETFs (like the three oil ETFs I mentioned), which allow you to invest precisely in the economic sectors you think are most likely to bring the biggest gains.

Each of the nine major U.S. sectors has its own ETF. Those are:

  •   Basic Materials Select Sector SPDR ETF (XLB): Companies like Monsanto and Dow Inc.
  •   Consumer Discretionary Select Sector SPDR ETF (XLV): Disney, McDonald’s, Nike.
  •   Consumer Staples Select Sector SPDR ETF (XLP): Coca-Cola, Wal-Mart, Proctor & Gamble.
  •   Energy Select Sector SPDR ETF (XLE): ExxonMobil, Chevron and ConocoPhillips.
  •   Financials Select Sector SPDR ETF (XLF): JPMorgan Chase, Wells Fargo and Bank of America.
  •   Health Care Select Sector SPDR ETF (XLV): Pfizer, Johnson & Johnson and Abbott Labs.
  •   Industrials Select Sector SPDR ETF (XLI): Caterpillar, Lockheed Martin, and UPS.
  •  Technology Select Sector SPDR ETF (XLK): Microsoft, AT&T, IBM and Cisco.
  •   Utilities Select Sector SPDR ETF (XLU): Exelon, Southern Co. and Dominion Resources.

Rarely would we recommend all of these ETFs all at once. When stocks are struggling like they were during the February and March 2020 coronavirus crash, for example, most sectors might take a hit, but that’s the time to load up on defensive utility stocks such as the ones you’ll find in XLU. When stocks are thriving, that’s the time to load up on high-growth sectors such as technology and consumer discretionary.

These sector ETFs are fairly broad; other funds are far more specific.

I recommend ETFs when I feel more strongly about the sector than I do about any individual stock, or when I feel there is too much risk in any one stock, yet I still want to participate in the sector. And I would certainly consider an ETF when investing in a more risky foreign country, say Turkey or Mexico.

I also might buy an ETF if I were very confident about a bull or bear market move and wanted to leverage the move by using an ETF that aimed for double the market’s move. Our resident growth expert, Mike Cintolo, does the same thing. He’ll occasionally invest in a major index—say, the S&P 500, by buying the SPDR S&P 500 ETF (SPY)—when he thinks it’s about to start a major upmove.

Of course, as I mentioned earlier, if your goal is to beat the market, you wouldn’t want to hold onto an index fund like the SPY in perpetuity; you can’t beat the market with a holding that essentially is the market. But it’s a good way to take full advantage of those big, short-term rallies.

The Bottom Line

There are some instances when investing in ETFs makes sense—whether it be gaining maximum exposure to a red-hot sector, gaining access to an entire country’s stock market, or simply taking advantage of a bull market. In general, we don’t recommend buying and holding ETFs the way you would a stock with long-term growth potential. But there’s money to made in ETFs if you time it right.

 

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