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How to Bet on Energy Stocks with ETFs for Quick Returns

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The energy sector has been stealing the show with the start of the New Year given that oil price is on a fantastic run thanks to geopolitical uncertainty, tightening supply and soaring demand.

Both West Texas Intermediate (WTI) and Brent opened above $60 per barrel on the first trading day of 2018, marking the strongest start since January 2014. Within a few days, Brent climbed to $70 per barrel for the first time since December 2014 while WTI broke above $64 per barrel. This has set the stage for a strong rally in the energy stocks for the near term (read: Oil Sees Strong Start to 2018 in 4 Years: ETFs to Play).

Strong Commodity Trends

Anti-government protests in Iran have sparked fears of unrest in the major oil producer, leading to threats of supply disruption. This coupled with Middle East tension and OPEC-led output cuts pushed oil prices to fresh highs. Notably, the OPEC, Russia and other producers started cutting production in January last year and are poised to continue for the whole of 2018.

Additionally, deteriorating economic situations in other large oil producers like Venezuela are also threatening oil output. Notably, Venezuelan oil production is falling by around 50,000 barrels a month, per the analyst at Norway-based DNB Bank.

On the other hand, freezing temperatures in the United States has spurred short-term demand, especially for heating oil. Improving global economic growth since the financial crisis, with consumption boom in both developed and emerging markets especially in China, and falling crude oil inventories have raised the appeal for the commodity. According to the data from the American Petroleum Institute, U.S. inventories fell by more than 11 million barrels in the first week of the year (read: Sector ETF & Stock Winners 10-Years Since Great Recession).

Moreover, the return of the state of backwardation (where later-dated contracts are cheaper than near-term contracts) in the oil market after three long years is acting as the biggest catalyst for the commodity. This signals that the oil market is tightening and demand is robust, paving the way for a further rally in oil prices.

Q4 Earnings Strength

Apart from commodity bullish fundamentals, strong earnings and revenue growth have been the key drivers of growth in the energy sector. Energy has been the major contributor to the S&P 500 earnings and revenue growth over the past two quarters and will likely to do so in Q4 as well. The sector is expected to post 177.4% earnings growth and 24.3% revenue growth, per the latest Earnings Trends.
 
How to Play?

Amid the strong 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.

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

ProShares Ultra Oil & Gas ETF (DIG - Free Report)

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 $144.2 million in its asset base and trades in a good volume of about 108,000 shares per day on average. DIG charges 95 bps in fees per year and gained 12.1% in the first few days of 2018.

Direxion Daily Energy Bull & 3x Shares (ERX - Free Report)

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 $500 million and average trading volume of around 1.8 million shares. ERX has surged 19.1% in the same time frame (read: Energy ETFs & Stocks Soaring to Start 2018).

Direxion Daily S&P Oil & Gas Exploration & Production Bull 3x Shares (GUSH - Free Report)

This fund offers triple exposure to the daily performance of the S&P Oil & Gas Exploration & Production Select Industry Index. It has accumulated $125.4 million in its asset base and average daily volume is solid at around 1.2 million shares. Expense ratio comes in at 0.95% and the ETF is up 17.7% to start the year.

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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