ETF Update: Time to Buy Oil Exploration Stocks?

|
 |  Includes: AAXJ, DOG, EEB, EWZ, FXI, GDX, GEX, PSQ, RSX, SH, VGK, XME, XOP
by: Jeff Miller

Energy stocks of all sorts have faced a double blow: The Big Spill and concerns about the global economy.

There is a fast-changing pattern of possible limitations on oil exploration. Meanwhile, oil prices have fallen to recent lows. The exploration stocks always seem to overreact to oil prices. My impression, admittedly based upon anecdotal information, is that many investors do not have futures accounts and use energy ETFs as a proxy.

If you are looking for a beaten-down sector that seems cheap, oil exploration is worthy of consideration.

Background

Traders all seek rewards but they have differing appetites for risk. It is important to find a method that suits your personality and needs. Our short-term trading systems are basically Trend-following, but also include recognition of Cycles and a touch of Anticipation. Since we apply the method to ETFs, we call it the TCA-ETF system. We follow two versions of this method, designed for two clients (Oscar and Felix) with different needs and risk appetite. [New readers can find more information about the models at the end of this article.] For convenience, we have named the models based upon the intended clients.

Featuring Oil Exploration

We trade oil exploration stocks via SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP). The fund is 67% exploration, 21% refiners, and 12% integrated oil and gas. No single holding is greater than four percent in this widely-diversified ETF. The dividend yield is only 0.5%. The P/E ratio is about 16, which is in line with long-term growth.

Here is the chart (click to enlarge).

XOP June 2010

I am a bit surprised that Felix likes this chart. My guess is that prices need to firm in the next few days, or it will be back to the penalty box for XOP!

Meanwhile, the rebound potential is clear if we can hold the trading range.

Other Opinions

We always survey commentary from other experts on ETFs in our buy zone. There has not been much commentary on XOP.

ETF Daily news liked the sector in late June.

ETF Database has a nice overview of many energy ETFs. The take on XOP mentions new regulations as well as the general resilience of the sector. I think it emphasizes big oil a bit too much, but check it out for yourself.

There are few recommending energy stocks, a group that I said to avoid in my preview for 2010. I am now actively reviewing energy candidates for all accounts, and we own XOP in trading accounts.

This Week's Results

Felix, the cautious approach, has continued to be mostly on the sideline with a slight negative lean. Nearly everything is in the penalty box. Felix sees the world as too unpredictable right now, but we are seeing a few attractive candidates.

Oscar, the more aggressive approach, is always looking for a way to win. Oscar is unafraid of the volatility and now has many suggestions for fresh buys -- mostly energy and emerging markets.

Weekly TCA-ETF Rankings

We are currently slightly long in our Felix ETF program and finding new buys for those following Oscar. (We are happy to report and discuss performance with interested investors. We also offer a report on how we use the models, and a free weekly email update. Write to etf at newarc dot com. Our actual trading is a combination of both models and some weekly timing).

As recently noted, I am changing the timing schedule for this weekly article. It will now appear mid-week, with a one-day delay in the ratings. The ratings below are from Wednesday's close.

Please note that these are not recommendations. Investor needs and risk tolerance varies. We hope everyone finds the ratings to be a useful supplement to their own work. The recommendations can change quite rapidly in this environment. It is quite possible for investors with different time frames to reach opposite conclusions about a specific trade.

Here are the current rankings for both Oscar and Felix (click on each chart to enlarge).

Felix 070110

Oscar 070110

Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETF's and Sector Rotation. We also have free reports, available upon request to etf at newarc dot com. These reports describe how we use the system, compare results from Oscar and Felix, and contrast the method with our long-term trading approach.

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 ETF's 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 ETF's. 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.

Oscar and Felix. We follow two versions of this method, designed for two clients with different needs.

  • Oscar believes in the long-term strength of the economy and the stock market. He has a lovable and irrepressible enthusiasm. When things go wrong, he steps back for a bit, but soon tries again. He expects to do better than others during good times. Oscar understands that this approach involves more risk. Oscar is opportunistic.
  • Felix also has a positive long-term outlook, but he is something of a fussbudget. He is much more cautious, with an emphasis on capital preservation. He is perfectly willing to step aside from the market when there are signs of danger. He knows that he will miss some moves, but that is OK. He scores big gains when the market moves lower and he escapes the loss.

There is more detail on Oscar and Felix in this article. There is more about the Penalty Box here.