With oil down more than 6% on Tuesday, the commodity’s three-day rally could prove to be just that: No more than a small rally in the midst of a prolonged bear market.
Oil’s surge provided some much needed relief to various single-country and sector exchange traded funds, but the pop has emboldened some market participants to reiterate bearish views on the commodity and those views are proving accurate Tuesday.
“At best, we think this is sideways [movement]with risk to the downside,” Ari Wald of Oppenheimer said on CNBC Monday. Wald notes the Energy Select Sector SPDR (NYSEArca: XLE) violated a long-term uptrend with its 2015 decline.
Meanwhile, in the lower oil prices are pressuring exploration and production stocks as the drillers’ value is based on production and assets already sunk into projects. [Energy ETF Investors Grow Wary of Oil Outlook]
Additionally, these energy companies require a lot of capital to keep drilling, and since depletion rates on wells are high, the companies will require cheap capital to keep operations running.
Should energy sector ETFs see more waning momentum, which is exactly was seen Tuesday, the UltraShort Oil & Gas ProShares (NYSEArca: DUG) and the Direxion Daily Energy Bear 3X Shares (NYSEArca: ERY) could prove to be winning trades. ERY attempts to deliver three times the daily inverse performance of XLE’s underlying index while DUG is a double-leveraged inverse play on the Dow Jones U.S. Oil & Gas Index.
Still, bargain hunters could be lured to energy stocks and ETFs. Valuations are also sitting at relatively attractive levels as well. Looking at the energy sector’s price-to-book ratio since 1990, the sector’s valuations are hovering near lows last seen during the financial downturn. However, investors should be careful with putting too much faith in what amounts to a brief rally in the energy patch.
“We’re worried that if the overall market does continue to crack here, it’s going to be because of this sector. For that reason, we’re staying away [from the XLE],” Wald said on CNBC.
ProShares UltraShort Oil & Gas
