How Can I – a Wee Plebe – Invest in This Volatile Market?

Bull Market Concept

Unleash your inner bull!

I just went to Getty images to round up another hilarious photo for this entry, and discovered that I am out under my subscription until next month… BLAAARGH… Nerd Rage!!!! (Hat tip, 30 Rock.) I seriously don’t know what I’m going to do with myself for the next week or so. Blog without photos, I guess… (sad trombone).

Anyway, enough about the travails of my stock photo account. I wanted to touch base today on another (yes, another) aspect of the oil and gas market – investing. Most people – well, let’s be honest, me – thought of oil investors as fat cats in wood paneled rooms sipping brandy and lighting cigars with $100 bills.

However, through the wonders of modern technology, you too can see your portfolio wiped free of cash in mere minutes!

First, though, a BIIIIIG disclaimer. I am not a financial analyst, guru, mentor, planner or any other person or entity on which you should rely in making ANY investment decision – except whether you should go to law school… to which the answer is almost always, “No, unless you can go for free.” I am ONLY providing opinionations here. Take them or leave them at your own initiative… don’t come crying to me if the don’t help… Or if my opinion would have helped you and you didn’t take it. 😀

A second tidbit… I am not in the market right now… which is to say, I have a 401(k), but am not actively trading and do not own any of the investments which I describe below. I am also not a spokesperson for any party, other than my legal clients, whether paid or unpaid… This is strictly my opinion, which should be taken with a large grain of salt.

Everyone is talking about exchange traded funds, or ETFs, these days. They are kind of a hybrid instrument of a hedge fund that is also traded on a normal stock exchange. Don’t take my word for it, though… Wikipedia is always a handy tool! This is kind of neat because, for us mere mortals, access to such funds is typically very limited (most hedge funds look for large investments from extremely wealthy individuals… NOT pennies from dumb country lawyers in West Texas.). What those funds are intended to do is match a certain class of other funds or investment vehicles.

Which is what brings us to the oil and gas portion of our discussion. You see, there are funds that trade in oil and gas investment opportunities as well! As before, this is kind of neat because it grants access to the plebeians who are usually barred from making commodities investments apart from investing in those companies directly engaging in that market. (Again, my humble advice is that one should be wary of e&p stocks right now… but what do I know???)

There are funds, like this one, which are supposed to trade at a price directly correlated to the value of the underlying asset. If oil goes up, then the ETF price should also go up by a similar percentage. Simple enough, no? Well, then! Allow me to complicate things for you just a bit… There are also vehicles wherein someone can make money if they believe that the price of the underlying commodity will go down… these are inverse ETFs, like this one – if the price goes down, then your investment will supposedly go up by a similar percentage.

That’s easy enough too, you say? Well, have I got the investment opportunity for you! Have you ever heard of leveraged ETFs? No? Great!

A leveraged commodity ETF is an investment where the rise or fall of the price is magnified by the rise or fall of the underlying commodity. If the leverage factor on the ETF is 100, then the rise or fall of the ETF price is supposed to be directly correlational. (Why does spell check tell me this word is wrong? Is this wrong? The interwebs says I’m right, and who can you trust if you cannot trust a series of tubes?) Leveraged ETFs will have a leverage factor of something like 200, or 300 or, perhaps, 400. This means that if the price rises by one percent, then your investment should rise by about 2%… or 3%… or 4%.

But, guess what! If you think that the price of a commodity will go down, then there are also inverse leverage commodity ETFs! These will have the same attributes as before, but the leverage factor will be -200, or -300 or, perhaps, -400.

Man, you say, that sounds great! How could it possibly go wrong???

Great question. The problem with correlations, like a LOT of statistical information, is that its often like trying to nail jello to a wall. Correlations are NEVER perfect, and if you pick up an interest in a poorly performing fund, you could either miss out on gains you should realize or get hurt worse than you otherwise would. If you “double down” or even “triple down” through the use of a leveraged vehicle, can you guess what that means? That’s right, you stand to lose 2-3x’s the amount you might have otherwise.

Which brings me to another warning – commodities ETFs are not for the faint at heart. They are also, in my opinion, a poor choice for long-term investments. Typically, I would hold an interest in a fund for a day or two – at MOST – and then divest it when it performed (hopefully!) the way that I thought it would.

When did I do this? Personally, as you may have guessed by now, I am a BIT of a contrarian when it comes to the oil and gas market. If I started noting a trend (like this past week, say) where the price was rising on fears of conflicts in Middle Eastern countries that do not produce oil, I would start to short oil stocks early in the week by investing in say, this ETF, which performed quite well for me in that role.

Why did I do this at the start of the week? Because inventory reports start coming out on Tuesday afternoon (for the API) and, as I have argued before, there have been no fundamental changes to the market forces by these engagements overseas. Therefore, inventory reports have, generally speaking, reaffirmed bearish signals in the market – like they did this week – which causes oil and gas investments to lose their value mid-week. By Wednesday afternoon, these forces typically peter out in large part, which is when I would divest myself of a short position… As shorts (like us in this hypothetical) bail out, there is usually some gain at the end of the week. This means that the price per barrel starts to rise, which gives us an entire weekend for someone to try and convince us the market has found its true bottom and is REALLY turning around this time! (Which, of course, starts the cycle anew again the following week.)

As you can guess… this strategy is hardly foolproof. In fact, it may even be foolhardy! That said, I was only venturing risk capital, and would recommend only the same to you. For example, I kept trying to up my leverage through the use of this fund, only to get repeatedly hammered by its inability (at that time) to correlate its price with the price swings of crude! Again, I say this not to disparage the fund (I just picked it up at unlucky times, I suspect), only to indicate the vagaries of correlations and the dangers of leverage.

Anyway, I’ve seen a great deal of information out there that has criticized these types of investments… Some of the critiques seem to be well founded. In my opinion, commodities ETFs should be undertaken with caution, and should not be used for long-term investments. With that said, however, these ETFs are also, I would argue here, a great democratization of the commodities markets. For people like me, who like to dabble, or even for individual day-traders, these are a wonderful way for people who would not otherwise have the ability to play in these markets to gain experience. Happy hunting!

This entry was posted in Investing, Oil & Gas, Oil Prices, Uncategorized and tagged , , , . Bookmark the permalink.

One Response to How Can I – a Wee Plebe – Invest in This Volatile Market?

  1. Pingback: Refineries Are Addicted to Crack | The Wolf Camp

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