Not all Trends Created Equally in Oil

Zurich, Switzerland

If an investor was shrewd enough to bulk-up on oil stocks on February 18, he’d find himself sorely disappointed three weeks later.

Sometimes, an underlying commodity, whose value is determined in the futures markets, will outpace its publicly-traded proxy in the same sector.

Oil prices provide a clear example of how these market-based anomalies can occur, resulting in a short-term deviation of portfolio returns.

Since February 18, West Texas crude oil has rallied a cumulative 22% compared to just 1% for the Energy Select SPDRs (NYSE-XLE).

Worse, a basket of the largest oil drilling stocks, as defined by OIH or the Oil Services HLDRs, has declined almost 3% over the same period.

That’s not the sort of correlation most commodity investors signed-up for since the recent outbreak of violence in oil-producing Libya; granted, oil stocks have been rising over the past few months as money-flows turn bullish recently. But the break in correlation isn’t good news for oil bulls loaded-up on energy stocks since mid-February.

It’s happened before.

In 2002, oil prices spiked more than 30% as most risk-based assets worldwide plunged in the last year of the 2000 to 2002 bear market. But XLE declined more than 10% that year – again failing to mimic the gains recorded in crude oil markets. The oil services stocks, as represented by OIH, were largely flat that year.

Gold stocks and physical gold bullion have also displayed similar divergences in the past, most recently in the 2008 credit crisis when gold bullion gained 5% but the mining stocks crashed more than 25%.

At the end of the day, commodity bulls should diversify their portfolios in both futures (ETFs, ETNs) and the publicly-traded natural resource shares. This way, the vagaries of market anomalies are reduced and total returns hopefully increased.

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