Bet On Resurgent Energy Sector With Leveraged ETFs

The struggling energy sector has staged a nice comeback given the wave of positive news that pushed oil price higher. Notably, oil price is on track for the largest third-quarter gain in 13 years buoyed by higher demand forecasts, resuming of refineries in the United States and signs of lower production.

In fact, the sector is leading the current market rally with the ultra-popular energy fund Energy Select Sector SPDR XLE (NYSE:XLE) climbing nearly 7.5% since it touched the low of $61.80 on Aug 21. The resurgence has made it the best performing sector ETF so far this month (see: all the Energy ETFs here).

Here are three reasons to be strongly bullish on the sector:

Higher Demand Outlook

Hopes of further extension to the OPEC output cut pact by at least three months are adding to the optimism in the oil market. As the deal aims to check the oil supply glut that has weighed on crude prices for more than three years, OPEC sees signs of a tighter global market and thus raised global demand outlook for this year and the next. The cartel expects global consumption to rise by 1.42 million barrels per day this year and 1.35 million barrels per day next year, up 50,000 barrels per day and 70,000 barrels per day, respectively, from the previous projection.

That was followed by a report by the International Energy Agency (IEA), which projects this year’s global demand to climb the most in two years as global glut has started to shrink due to stronger-than-expected consumption in Europe and the United States as well as production decline in OPEC and non-OPEC countries. It raised the global oil demand outlook by 1.7% to 1.6 million barrels per day for this year and by 1.4% to 1.4 million barrels per day for the next.

Lower Production and Reducing Inventory

The historic output cut deal wherein OPEC, which accounts for one-third of the global output, Russia and other producers agreed to curb production by 1.8 million barrels per day until next March, is now paying off. This is especially true as OPEC oil output declined in August for the first time since March. The 14-member cartel pumped in 32.76 million barrels per day last month, representing a 79,100-barrel-per-day drop from July (read: ETFs to Watch on Oil Price Rise and Debt Limit Deal).

Though inventories in developed economies are above the five-year average, it is declining and will soon fall to that level given a robust demand outlook and falling supplies. Unrest in Iraq and Venezuela will also keep output at check. Further, the U.S. Energy Information Administration lowered its oil production forecast for this year and the next by 1% and 0.7%, respectively. The agency expects crude production at an average 9.25 million barrels per day for this year and 9.84 million barrels a day for the next.

Strong Earnings Expectation

Strong earnings growth has been the key driver for the growth in the energy sector. The sector has been the major contributor to S&P 500 earnings growth in Q2 and is expected to do so in Q3 as well with expected 118.8% growth, per the latest Earnings Trends.

How to Play?

Amid the fresh round of optimism, many investors have turned bullish on the energy sector and are seeking to tap this opportunity. For them, a leveraged play on energy could be an excellent idea as these could see huge gains in a very short time frame when compared to the simple products (read: How to Trade the Oil Rally with ETFs & Stocks).

Below, we have highlighted leveraged ETFs that could be excellent picks:

ProShares Ultra Oil & Gas ETF (AX:DIG)

This ETF seeks to deliver twice (2x or 200%) the daily performance of the Dow Jones U.S. Oil & Gas Index. It has been able to manage $141.2 million in its asset base and trades in a good volume of about 138,000 shares per day on average. DIG charges 95 bps in fees per year and gained 15.8% in one month.

Direxion Daily Energy Bull & 3x Shares (AX:ERX)

This fund creates a triple (3x or 300%) leveraged long position in the Energy Select Sector Index while charging 95 bps in fees a year. It is a popular and liquid option in the energy leveraged space with AUM of $560 million and average trading volume of more than 2.5 million shares. ERX surged 24.4% in the same time frame (read: Capex Cuts Are Back: What's in Store for Energy ETFs?).

Direxion Daily S&P Oil & Gas Exploration & Production Bull 3x Shares GUSH

This fund offers triple exposure to the daily performance of the S&P Oil & Gas Exploration & Production Select Industry Index. It has accumulated $151 million in its asset base and average daily volume is solid at around 1.3 million shares. Expense ratio comes in at 0.95% and the ETF is up 31.5% in one month.

Bottom Line

As a caveat, investors should note that these products are extremely volatile and suitable only for short-term traders. Additionally, the daily rebalancing – when combined with leverage – may make these products deviate significantly from the expected long-term performance figures (see: all the Leveraged Equity ETFs here).

Still, for ETF investors who are bullish on the energy sector for the near term, either of the above products can be an interesting choice. Clearly, a near-term long could be intriguing for those with high-risk tolerance, and a belief that the trend is the friend in this corner of the investing world.

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