ETF Update: Profiting from the Search for Oil

by: Jeff Miller

Oil prices are far below the 2008 peak, but some are looking to the future. While there is always an active debate over energy prices, there is currently special attention being paid to the search for new energy sources. The future may hold improved prospects for alternative energy. For the present, the world depends upon fossil fuels.

Major energy companies have become active in the quest for new sources of oil and natural gas. This is reflected in deal making, and in the stocks of the companies in the energy sectors. In this article I will review some of these factors with a special focus on ETF trading.

As usual, let me begin with some background about our approach and our perspective on the overall market.


Each week we provide a list of sectors including those that we expect to have the best performance over the next three weeks. ETF investors can check out the list and compare our findings with their own conclusions.

In our analysis, we consider Trends, Cycles, and a bit of Anticipation. While our ratings share characteristics with momentum and relative strength approaches, there are important differences. Since we apply the model to nearly 300 ETFs, we call it the TCA-ETF system. (For new readers, there is a more complete description of our methods at the end of the article. We also have a free report with more detail on the system and results, available on request.)

The model provides a nice feel for the overall potential of the market. It is not the forest nor the individual trees, but something in between.

The Macro View

From an overall market viewpoint, our indicators show strength, but continued risk. The key elements are as follows:

  • 96% of our ETFs in positive territory (equal to last week). The median strength rating for the overall list is a plus 34 (down from +42 last week). A score of "0" implies the average long-term ETF expectancy.
  • We see continuing and rising risk, with 66% (up from 58% last week) of our sectors in the "penalty box." This means that they are currently disqualified from the buy list for technical reasons. You can think of this as a sophisticated "stop loss" rule, often applied in advance. It also may indicate the need to take profits in a sector where we have done well, but see higher risk. See our article here for a further explanation of this method. We recently implemented some faster filters, accelerating moves both into and out of the Penalty Box. We are also changing some rules to cut down the frequency of trading.
  • Our index package is still positive. For this rating we look at the ETFs (both long and short) for the S&P 500, the Dow, and the Nasdaq. You can see these ratings in the results table for this week. Despite the positive ratings, we note risk in both directions. All of the index ETFs are in the penalty box.

This overall picture has been about the same for several weeks.

Featuring Energy Exploration

Oil and Gas Exploration stocks have attracted recent attention, particularly after last month's Exxon (NYSE:XOM) takeover of XTO Energy (XTO). We trade the sector via the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP). The fund has a P/E of about 21, and more importantly, a price to cash flow of about 7. Earnings growth is estimated at around 12%. The beta is 1.44. Even the largest holdings in XOP are only about 3% of the fund, so there is little concentration. Investing in this sector depends more upon your expectation for future energy development than an interest in current earnings or dividend yield, which is less than one percent.

Here is the chart (click to enlarge).


In our current trading universe we are using XOP in preference to some similar alternatives. Because of our trading frequency, we pay special attention to volume, liquidity, and the bid/ask spread. We also prefer ETFs with relatively equal weights for all components.

Other ETF Experts

I always take a look at comments from the ETF expert community for additional insight on our highlighted sector. This week we need to look beyond the ETF experts to get the full picture.

Tom Lydon sees a mixed picture in a brief survey of 2010 prospects, especially for natural gas.

Michael Johnston mentions IEO (a close alternative to XOP, and currently higher in our rankings) as a possible candidate for those concerned about inflation.

Jim Cramer is on the case. Check out this interview (via Vincent Fernando) with the CEO of Anadarko Petroleum (NYSE:APC).

24/7 Wall St. also has good coverage of Cramer's energy picks.

Finally, Total is teaming up with Chesapeake Energy in a joint exploration venture.

There is plenty of action in the energy exploration space. These articles are only a sample of the news in this sector.

Weekly TCA-ETF Rankings

We gained over 5.5% last week, beating the S&P 500 by 3%.

We provide these ratings as information for readers who may not trade as frequently as we do. Those signing up for our free weekly email update can also get the entire list.

As noted above, the macro market indicators are in the penalty box, and most other ETFs are in the penalty box. Based upon the current model signals (and noting the high risk levels), we have continued our bullish posture in the Ticker Sense Blogger Sentiment poll.

Here are the top sectors from our expanded universe of 280 ETFs. The list also includes the values for the broad market ETFs and their inverses (based upon Thursday's close).


Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETFs and Sector Rotation. Before turning to the current rankings, let us undertake a review for readers new to this series.

Our Method. In this past article, we described our basic methodology and why we believe the rankings are useful for fundamental traders and technical traders alike. While we urge readers to check out the entire article, the key point is that ETFs pose challenges and opportunities different from investment in individual stocks. The fundamentals may be more difficult to assess. Even with a good grasp on fundamental trends, there is a lot of technically-based trading in ETFs. This means that those trading with a fundamental approach (and we do this as well) want to monitor the "hot money" moves. Here is an article on that point.

The system synopsis. We look at Trending sectors, Cyclical Sectors, and build in an element of Anticipation for both entry and exit -- thus the name of the model, TCA-ETF. While we do not reveal the exact methodology for spotting trends and cycles, the system is not a "black box." The basic elements are used by many, and widely reported. We even discuss the need for human analysis as opposed to black box trading.

We report the rankings each week, now on the weekend with a one-day delay, using the Thursday output from the model. We monitor and trade this daily, and offer a free report (request via the email address on the top left of the site) for those interested in our weekly trading program.