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Pain or Gain Ahead for Oil & Energy ETFs?

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Things have been topsy-turvy in the oil patch. Oil slumped into bear market this week as U.S. crude stockpiles hit the most since 1990, raising concerns of a supply glut especially amid tariff wars and expected global growth slowdown.

U.S. crude production also set a record, while imports climbed. However, the liquid commodity recoiled on Jun 6 thanks to a report that Washington could defer trade tariffs on Mexico and cues of extension of output cut by OPEC and other producers.

Against this backdrop, investors would be interested in knowing the course of oil in the coming days. United States Oil Fund, LP (USO - Free Report) is up 14.5% this year while it has slumped 13.1% in the past month. United States Brent Oil Fund, LP (BNO - Free Report) is off 9.2% in a month and has gained 18.3% this year.

Will Brent be at $70/barrel?

A Wall Street Journal survey of 10 investment banks finds an average Brent forecast of $70 per barrel for the year, per Brent is now in the low $60s, so major analysts are largely brushing aside the current dive and believe that crude will turn around eventually. The drivers of the future oil rally would be “tightening supply conditions due to declines in Venezuela, Iran, potentially Libya and temporary outages from Russia.”

 Investors should note that,in early 2019, the Trump administration imposed sweeping sanctions against Venezuelan state-owned oil firm Petróleos de Venezuela, S.A. PDVSA makes up nearly all of Venezuela’s exports. And U.S. sanctions came in response to the re-election of socialist President Nicolas Maduro, a vote broadly viewed as sham. The United States also recently intensified its efforts by targeting the Venezuela’s petrochemicals industry (read: Oil Jumps: 4 ETFs to Benefit & 4 to Suffer).

Added to this, the almost year-long U.S.-Iran tensions worsened in late April as Washington has announced that it won’t renew waivers previously granted on Iran oil import sanctions. Apart from these, output cut from the OPEC and non-OPEC allies is in place. The market is also waiting for a decision from the OPEC and other producers if they could prolong the cuts and shore up prices (read: Energy ETFs Rallying on Gulf Crisis: 5 High-Yielding Winners).

Also, the Fed is signaling a rate cut should the need be. If this happens, global growth prospects should brighten. Also, the greenback will remain on the lower side, which in turn will boost the commodity investing like oil (read: ETF Strategies to Win If Powell Enacts Rate Cuts).

Wall of Worry?

U.S.-China and U.S.-Mexico trade tensions are the key concerns. President Donald Trump administration has lifted tariffs on $200 billion worth of Chinese goods from 10% to 25% on May 10 and China imposed a tariff hike on $60 billion of American goods to 25% starting Jun 1.

Also, in late May, Trump announced tariffs on all goods imported from Mexico in order to curb illegal immigration. He said that the first round of tariffs will be put into effect on Jun 10 at 5%.

The Trump administration further warned that if Mexico does not bar “illegal migrants” from entering the United States, tariffs would go up to 10% by July, 15% by August, 20% by September and reach a permanent level of 25% by October (read: How Bad Are Trump Tariffs for Mexico ETFs?).

All these trade conflict will nothing but slow down global growth. Per IMF, “the current and threatened US-China tariffs could cut 2020 global gross domestic product by 0.5%.” So, the fate of oil price largely depends on the future of trade war.

ETFs in Focus

Against this backdrop, investors should keep a close eye on oil ETFs like USO and BNO and broader energy ETFs like Energy Select Sector SPDR Fund (XLE - Free Report) , Vanguard Energy ETF (VDE - Free Report) , SPDR S&P Oil & Gas Exploration & Production ETF (XOP - Free Report) and so on.

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