Energy ETFs Slow Down

ETFZone

Energy Sector ETFs are underperforming broad market benchmarks. Is this a temporary phenomenon or a structural trend?The energy sector has not had a good year. Crude prices are trading on the macro story. When the economy does well, oil prices are higher and energy ETFs do well. But estimates for global output proved too rosy. Crude prices are lower on weaker demand. The massive BP environmental disaster adds to the jinx. A ban on offshore drilling and the possibility of new taxes and restrictions are creating additional uncertainty for ETF investors. Energy ETFs are sometimes attractive as a dollar or inflation hedge. But inflation is absent and the dollar is stronger.This apparent turn of fortune for energy ETFs over the last few months is striking because the sector has been one of the most consistently profitable over the past decade. Energy Sector ETFs hold primarily major oil, oil gas, and oil service stocks, including drillers and refiners. Exxon Mobile (NYSE:XOM - News) and Chevron (NYSE:CVX - News) are typically among the largest holdings.The two charts below compare a key energy sector ETF, the Energy Select Sector SPDR (PCX:XLE - News) with the broad market benchmark Standard and Poors Depository Receipts (NYSEArca:SPY - News). The first chart compares the 5-year performance of these two funds. The second chart compares their year-to-date performance.

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The first chart shows the particularly strong performance of XLE through mid-2008. The second chart makes plain that XLE has traded below the SPY for most of this year. Part of the reason for the long-term outperformance of Energy ETFs was a steady increase in the price of crude during this period. Crude is priced in dollars. This makes crude and energy ETFs sensitive to big moves in the dollar. In the summer of 2008 the dollar fell to all-time lows against the euro and other currencies. This made oil attractive as a hedge. It helped boost the price of Energy ETFs. This trend peaked in July 2008. In July $1.50 USD bought a single euro and oil moved to a high of $147/barrel. These were new highs for both oil and the European currency.The second half of 2008 reversed the long-term trend to higher crude prices. In an about face, the dollar increased against the euro. Oil prices fell sharply. Both trends accelerated after the collapse of Lehman Brothers. Amidst the ensuing economic crisis, global demand disappeared. 6 months later, oil traded below $40/barrel. Energy ETFs followed crude prices lower.As the first chart above indicates, the collapse in the price of energy sector ETFs, though dramatic, was not out of sync with the general market.Some investors are reconsidering the high multiple that energy ETFs have garnered in recent years. The current P/E ratio of XLE is 12, essentially the same as the general market. The SPY has a P/E ratio of 13. Energy ETFs, including XLE, have only slight exposure to BP. But the oil spill in the Gulf was a reminder to many investors that energy companies, while immensely profitable, also involve risk.The long-term outperformance of Energy ETFs may not be over but it has probably stalled. Energy ETFs are suffering from a lack of catalyst. There seems to be little incentive to buy energy ETFs now. Crude is not trending higher. There is little inflation. The dollar has been mixed over this period, but generally trending stronger. There is a new awareness of political and environmental risk.For energy ETF investors and hedgers there are plenty of options for investing in energy. Up from just a handful of broad market ETFs a few years ago the sector is represented today by an impressive, even bewildering, array of products. There are a number of specialized energy ETFs, including energy sub-sector ETFs, energy strategy ETFs, and alternative energy ETFs. There are also ETFs that hold primarily commodities futures contracts and seek to track the price of oil and other refined products, finally there are leverage and specialized trading funds. The most important of these ETFs are listed below:Broad-sectorEnergy Select Sector SPDR Fund (NYSEArca: XLE - News)Vanguard Energy ETF (NYSEArca:VDE - News)iShares Dow Jones U.S. Energy Sector Index Fund (AMEX:IYE - News)iShares Goldman Sachs Natural Resources Index Fund (NYSEArca:IGE - News).Sub-SectorSPDR S&P Oil & Gas Exploration & Production ETF (NYSEArca:XOP - News)SPDR S&P Oil & Gas Equipment & Services ETF (NYSEArca:XES - News)iShares Dow Jones U.S. Oil Equipment & Services Index Fund (NYSEArca:IEZ - News)iShares Dow Jones U.S. Oil & Gas Exploration & Production Index Fund (NYSEArca:IEO - News)Raw MaterialsUnited States Oil (NYSEArca:USO - News)United States 12 Month Oil Fund (NYSEArca:USL - News)PowerShares DB Oil Fund (NYSEArca:DBO - News)United States Gas (NYSEArca:UGA - News)United States Heating Oil Fund (NYSEArca:UHN - News)United States Natural Gas Fund (NYSEArca:UNG - News)Global/ForeigniShares S&P Global Energy (NYSEArca:IXC - News)WisdomTree International Energy Sector Fund (NYSEArca:DKA - News)Claymore/SWM Canadian Energy Income (NYSEArca:ENY - News)StrategyPowershares Dynamic Oil & Gas Services Portfolio ETF (NYSEArca:PXJ - News)Powershares Dynamic Energy Exploration & Production Portfolio ETF (NYSEArca:PXE - News)Powershares Dynamic Energy Sector Portfolio ETF (NYSEArca:PXI - News)Trading/LeverageProShares Ultra DJ-AIG Crude Oil ETF (NYSEArca:UCO - News)ProShares UltraShort DJ-AIG Crude Oil ETF (NYSEArca:SCO - News)ProShares Short Oil & Gas ETF (NYSEArca:DDG - News)Ultra Oil & Gas ETF (NYSEArca:DIG - News)UltraShort Oil & Gas ETF (NYSEArca:DUG - News)Energy Bear 3X - Triple-Leveraged ETF (NYSEArca:ERY - News)Energy Bull 3X - Triple-Leveraged ETF (NYSEArca:ERX - News)ETNsGoldman Sachs Crude Oil Total Return ETN (NYSEArca:OIL - News)PowerShares DB Crude Oil Double Short ETN (NYSEARca:DTO - News)PowerShares DB Crude Oil Long ETN (NYSEArca:OLO - News)Dow Jones-AIG Natural Gas Total Return ETN (NYSEArca:GAZ - News)Jonathan Bernstein has been writing about ETFs since 2003 and is the author of Sector Trading: A Year in Exchange Traded Funds.

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