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Commodity ETFs

The geopolitical situation in many established oil markets to start 2012 hasn’t exactly been favorable to those looking for a cheaper crude price in the new year. Tensions with Iran continue to remain high while Russia, thanks to political uncertainty, could be a wild card later on in the year. Both of these situations could help crude to remain above $100/bbl. and keep many producers focused in on more politically favorable locales such as the U.S. and Canada for more oil production.

Yet, with traditional oil sources more or less tapped out (or off-limits) in North America, many producers are looking to other ways to play the oil market, specifically with oil shale. This conventional oil substitute, which is generally produced from sedimentary rocks, has gained in popularity in recent years thanks to a higher oil price and better technology which makes accessing this fuel source that much more profitable (also see Is USCI The Best Commodity ETF?).

Thanks to this increased profitably and the greater demand for oil from friendly nations, investors would be wise to consider taking a closer look at the space. While there a few stocks that are available to American investors in this corner of the market, arguably the best way to play the sector is with a fund from Guggenheim, the Canadian Energy Income ETF (ENY - ETF report). Below, we take a closer look at this popular fund in order to give investors a better idea if this product could be a solid choice for their portfolios:

Canadian Energy Income ETF In Focus

This fund tracks the Sustainable Canadian Energy Income Index which is comprised of 34 stocks selected, based on investment and other criteria, from a universe of firms in the energy industry. This includes approximately 200 TSX listed oil and gas sector securities including royalty trusts, as defined by the TSX, and approximately 25 oil sands resource producers that are classified as oil and gas producers. Currently, the product charges investors 65 basis points a year in fees and trades about 51,000 shares a day, giving the product decent volume for most investors (also see Inside The FlexShares Natural Resources ETF).

Yet, investors should note that the fund doesn’t just randomly allocate assets to the sector or even focus on market capitalization levels in order to determine its holdings. Instead, the index selection methodology is designed to combine the highest yielding Canadian energy related securities with the most highly focused and fastest growing oil sands producers using a tactical asset allocation model based on the trend in crude oil prices. When the current quarter’s closing price is above the four quarter moving average price, crude is determined to be in a bull market. Then, when the price of crude oil is closing below the four quarter moving average, oil is deemed to be in a bear phase (also read Time To Consider The Silver Miners ETF).

When oil is determined to be in a bull market, oil sands firms make up 70% of the portfolio and leave 30% for Canadian high yield energy equities. Then, when oil is determined to be in a bear market, the ratios reverse and Canadian high yield energy equities make up the bulk of the portfolio instead. Crude oil price trends are evaluated 15 days prior to the end of each calendar quarter and tactical asset allocation adjustments are implemented on the first trading day of the new quarter.

The Canadian energy income constituent selection methodology is an equal weighted allocation to the top 20 highest yielding Canadian energy equities that pass minimum criteria for equity and market capitalization. The oil sands producers are selected on the basis of their focus on oil sands production, current production rate and projected production during the next 10 years. The oil sands producers must also pass minimum market capitalization and liquidity thresholds. Index constituents are updated annually or whenever a major corporate event occurs such as a merger or acquisition.

Thanks to this methodology, the fund is heavily exposed to oil sands and far less to the high yielders of the Canadian oil world. Currently, top holdings include Canadian Oil Sands LTD , Baytex Energy Corp (BTE - Snapshot Report), and Husky Energy which make up 6.2%, 5.2%, and 4.4% of the portfolio, respectively. With this focus, the fund has largely underperformed over the course of 2011 falling by 12.8% over the course of the year compared to a 4.4% gain for (XLE - ETF report) and a 8.6% gain for the leading MLP product, AMJ. However, now that oil has begun to once again surge to triple digit levels, ENY has been a star performer posting a 33.6% gain in the past three months compared to a roughly 20.5% average gain for the other two products. This suggests that ENY can outperform other energy-centric products when oil is surging to new heights making the fund an intriguing pick for those that are looking for a bull market in oil during 2012 (also read Time To Buy The Rare Earth Metals ETF?).

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Long ENY.

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