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ETF Periscope: Oil Speculators Get Spanked. Or Did They?

Posted on the 27 June 2011 by Phil's Stock World @philstockworld

Courtesy of Daniel Sckolnik, ETF Periscope

ETF Periscope: Oil Speculators Get Spanked. Or Did They?

by Daniel Sckolnik of ETF Persicope

“It is better to travel well than to arrive.” — Buddha

ETF Periscope: Oil Speculators Get Spanked. Or Did They?
Watching crude oil take a serious plunge this week gave motorists a reason to cheer, but left oil traders with a strong, queasy feeling.

Well, at least some of them.

On Thursday, New York Mercantile Exchange (NYMEX) crude fell below $90 a barrel for the first time since mid-February, finally ending the day at $91.02, down 4.6%.

The reason? The International Energy Agency (IEA) announced earlier that the 28 IEA member countries have agreed to release 60 million barrels of oil over the next 30 days, in effect attempting to make up for the disruption of oil supplies from Libya. The U.S., one of the IEA members, promised to contribute to the cause by releasing 30 million barrels of oil from the Strategic Petroleum Reserve (SPR).

This was a pretty radical course of action on behalf of all the players. How radical? Well, it was only the third time in the history of the IEA that they have taken such action. And the U.S.? Well, put it this way. It is generally a given that the SPR is there to be used for emergencies. But is a slight tightening of supply out of Libya really an emergency? Have we suddenly run out of oil, and need to tap the national stash? Hardly.

Something else is going on, though it is yet unclear as to exactly what. Sure, the efforts by the IEA had an immediate effect on the price of oil. A near 5% drop is quite a harsh response, and an obvious indication that market prices can be tamped down by a collective, multi-national effort.

Still, it seems like a pretty extreme reaction to the current situation, and the timing is hard to figure. Cynics might wonder if the effort to lower the cost of oil, and in turn bring a drop to the cost of gas at the pumps, is a pure political play. Others might say that the government is loudly clearing its throat in the direction of oil speculators, who have been accused of trying to game the market.

But accusing speculators of any persuasion of gaming the market cannot help but bring to mind the classic Casablanca scene where Humphrey Bogart’s nightclub gets closed down by a government official who expresses the sentiment that he is “shocked, shocked, to find gambling going on in this establishment!”

Of course, the punch line is that even before he is done expressing his outrage, a croupier is handing the very same official his roulette winnings.

The thing that some people seem unaware of is that speculators can play both sides of the field. They are not always betting that prices will go up. Far from it.

As if to emphasize that point, U.S. commodity regulators are examining the very suspicious fact that oil prices sank just hours before the IEA announced the coordinated release. Naturally, the Commodity Futures Trading Commission is looking into a possible leak. Interestingly enough, trading on leaked data isn’t illegal in commodity markets.

Go figure.

But it does make a perverse kind of sense. As one oil analyst suggested in reference to the IEA, “Twenty-eight countries—it’s tough to keep a secret.”

Indeed.

So, if you really think about it, while some speculators certainly got soundly thrashed, likely an equal number made off, yet again, like bandits.

Other points of interest along Wall Street included the fact that the International Monetary Fund and the European Central Bank indicated that they would likely move forward with an additional bail-out for the Greek government. However, that generosity would only be extended should Greece’s prime minister manage to convince the country’s lawmakers to accept a rather extreme package of austerity measures. This announcement seemed to calm the equity markets somewhat. But that calm is likely to be short lived. Why?

Because getting his country’s lawmakers to agree to the rather draconian recommendations is somewhat akin to saying President Obama just decided to raise taxes, all he has to do is persuade the Republican led House to go along with the idea.

That’s all? Really?

The spanking may not be quite finished yet.

What the Periscope Sees

(Note: In my search for a clearer read on the markets, I often reference Sabrient’s ETFCast Rankings.  It consists of over 300 ETFs [exchange-traded funds[ that are ranked and scored via nineteen of Sabrient’s proprietary analytics, that, when taken together, offer a forward-looking take on the markets.)

At the end of May, ETF Periscope offered a hedged pairs approach to help navigate through the volatile market environment. Since then, not much has changed in terms of volatility. The Dow dropped over 500 points during the last three weeks, while the suggested pairs, IYM and IAT for the upside, and RTL and FXU for the downside, also dropped lower. However, the shorts outperformed, and the longs held their own, so the play was a solid success.
Now, in an effort to continue to explore the hedged pairs strategy, here are four different ETFs that might be considered as another possible hedged strategy play.

In this week’s top 10% of the ETFCast Rankings is XLK (Technology Select Sector SPDR Fund), an exchange-traded fund that invests in the stocks of companies operating in the technology sector; specifically, it invests its corpus in the common stocks of companies that form the Technology Select Sector Index in proportion to their weightings in the index. The fund seeks to replicate the performance of its portfolio against that Index.

Also in the top 10% of the Rankings is XLV (Health Care Select Sector SPDR). It tracks the Health Care Select Sector Index, which includes companies from the following industries: pharmaceuticals, health care providers and services, health care equipment and supplies, health care technology, biotechnology, and life sciences tools and services.

On the flip side, IYZ has a “near to the bottom of the barrel” ETFCast Ranking. IYZ (iShares Dow Jones U.S. Telecommunications Sector Index Fund) is a non-diversified exchange-traded fund that seeks investment results that correspond generally to the real estate sector of the U.S. equity market, as represented by the Dow Jones U.S. Select Telecommunications Index.  The fund invests its corpus in common stocks of companies that form the Dow Jones U.S. Select Telecommunications Index as per their weighting in the index.

Also towards the bottom of the Rankings is RGI (Rydex S&P Equal Weight Utilities ETF), an exchange-traded fund that invests in stocks of companies in the Utilities Sector and specifically those listed in the S&P Equal Weight Index Utilities in proportion to their weighting in the Index. The fund seeks to replicate as closely as possible, before expenses, the performance of the S&P Equal Weight Index Utilities.

You could consider going long XLK and XLV and shorting IYZ and RGI, creating the hedged pairs play. As an alternative, one could purchase near month, slightly out-of-the-money calls on XLK, and near month, slightly out-of-the-money puts on IYZ and RGI.

Of course, you can also move everything into cash and go to the beach and ride the surf instead of the volatility waves the markets are certain to throw at investors throughout the ensuing summer months.

ETF Periscope

Full disclosure:  The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Sabrient. Sabrient makes no representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.

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