Monday, December 27, 2010

Oil ETF v Oil Stocks? No Real Choice for Individual Investors

In some commodities investors have a viable choice between buying an ETF that attempts to reflect the movement of the commodity versus buying stocks that are related to that commodity.  For example, gold etf v gold stocks or silver etf v silver stocks.  However many commodity ETFs are highly flawed due to their construction - they deal in contracts that must be rolled out each month and hence cause a lot of dislocations in price, and the investor does not get the bang for their buck.  You might see said commodity rise 17% and you wonder why your ETF which is tracking that commodity is up 3%.   Oil is one such commodity.  The most popular ETF that I know of to track the commodity is the United State Oil Fund (USO) which trades nearly 9M units a day, and has close to $2B worth of assets.  But while crude oil is up some 14%ish for the year, USO has returned 0%.  Hence, in this case there really is no choice in the "do I buy the commodity or the stock?" debate if you are not an institutional trader who has access to the commodity pit itself.

While not a huge fan of buying ETFs to cover a host of stocks in a sector rather than picking or choosing a few individual names myself, the oil space is one area I do like the ETF strategy, since there are so many public exploration companies and most tend to move together in our "HFT + EFT" driven market.  As goes one oil stock, so shall go most of them as HAL9000 and his merry crew make a decision to move en masse to the hot new sector.  Now not all ETFs are made the same and the oil space is no different - many times you will see ETFs top loaded with the big boys like Exxon (XOM), Chevron (CVX) and a few huge integrated companies.  Rather than go that route a far more inclusive ETF would be something like SPDR S&P Oil & Gas Exploration & Production (XOP).  Here are the top 10 holdings as of 11/30/2010.  We see it is not concentrated in a few mega cap names, and indeed the top 10 holdings only make up 1/3rd of the entire portfolio.  You even have some refiners thrown into the mix for a truly broad exposure to the sector.  XOP is also liquid with some 3.6M units trading each day, unlike many other sector specific ETFs.

SPDR S&P Oil & Gas Exploration & Prod: Top holdings

Top holdings
Company name% Net assets
Atlas Energy Inc3.76%
Tesoro Corporation3.29%
Newfield Exploration Company3.26%
Concho Resources, Inc.3.24%
EXCO Resources, Inc.3.23%
SM Energy Co3.19%
Holly Corporation3.14%
Pioneer Natural Resources Company3.09%
Anadarko Petroleum Corp.3.03%
Whiting Petroleum Corporation3.02%

Percentage of holdings  32.25%

How has an ETF like USO compared to an ETF like XOP?  Clearly one has been the superior performer and in 2010 at least has actually surpassed the performance of the physical commodity itself.

[click to enlarge]

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