Buying Oil ETFs On A Dip

August 08, 2011

Oil has fallen sharply in the past week on worries about slowing growth and S&P’s downgrade of U.S. debt. So, if this is a buying opportunity, which ETFs are best?

WTI futures have tumbled almost 14 percent in the past week from $97 to around $83.33, more than 4 percent of which occurred today. Brent futures, which currently trade at a premium to WTI, are down almost 9.4 percent to $105.98. Nearby Brent was as high as $120.40 a week ago.

So, is this pullback a sign of depressed oil prices to come, or an opportunity to profit from prices that are bound to head back up?

While the stock market dropping is a cause for concern, it doesn’t mean oil is certain to decline too. The S&P 500 reached a high of 1576.09 on Oct. 11, 2007. Nine months later the S&P500 was down 23.36 percent. During that same period oil went from $83.08 to $147.27 – a return of more than 77 percent.

Nearby WTI prices did, however, dip to less than $34 in the midst of the 2008-2009 market meltdown, reflecting the clear relationship between recessions and collapsing oil prices.

But if you’re in the buying-opportunity camp right now, my sense is that WTI may offer more profit potential.

WTI is down almost 27 percent from a high of $114 reached in May, while Brent has dipped almost 12 percent from its high. Brent oil, via a fund such as The United States Brent Oil Fund (NYSEArca: BNO), has outperformed the numerous WTI funds, which makes me think WTI is where much of the upside movement in crude prices will come from.

The most crucial variable in choosing among competing ETFs is your time horizon, as the table below makes clear.

For investors looking to profit from a very short-term increase in crude oil, say, over the next week, the United States Oil Fund (NYSEArca: USO) offers a good choice. USO has an average daily dollar volume of $932 million, more than all of the other crude oil funds combined. It only invests in front-month WTI NYMEX contracts, which are the most responsive to very short-term movements in oil.

The iPath S&P GSCI Crude Oil Total Return Fund (NYSEArca: OIL), like USO, only has front-month exposure, but it does in an ETN structure, which means investors assume credit risk associated with the bank that issues the note, Barclays in the case of OIL. On the other hand, ETN allow investors to avoid K-1 tax forms associated with futures investing, which many consider to be something of a pain.

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