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Big Oil Portfolio – Reviewing It After The Recent Lows

Summary Like all other oil investments, the Big Oil Portfolio has taken a significant hit over the past few months. The fundamentals of none of the portfolios in the company has changed, instead, the only that has changed has been oil prices. The portfolio has a large amount of cash at hand should future opportunities present themselves. Introduction I have not provided an update for my Big Oil Portfolio since July . However, over the past few weeks, oil (NYSEARCA: USO ) has taken a significant hit dropping down to recent lows of less than $40 per barrel. The goal of this article is to take another look at the Big Oil Portfolio since the last update. Last Five Year Oil Prices – Bloomberg Oil prices remained relatively constant from 2011 – 2014. However, since reaching a peak, oil prices took a major hit dropping down to a bottom in January 2015. Oil prices bounced back up and then dropped back down forming a double bottom in March 2015 before recovering to around $60. In recent weeks, two majors things have weighed down on the market. The first was slowing economic growth in China, a major economic producer. The second was fears of a nuclear deal being signed with Iran which would result in a significant market glut. This resulted in another drop down in oil prices down to less than $40 per barrel followed by a recent small recovery. Goal The Big Oil Portfolio was originally created during a period of higher oil prices with the stated goal of building a strong portfolio for a recovery in oil prices. The goal of the article was to take a hypothetical person with $100,000 to invest in oil stocks. In this case, we will assume that you want to invest in large oil companies that are financially secure and will provide investors with income for many years to come. There are several reasons to invest in financially secure large caps during such a crash. However, the biggest one are the two words, ‘financially secure’. Should the oil crash last for longer than expected or get worse than expected, these companies will be able to last significantly longer than the competition. Portfolio Name Number of Share Purchase Price Current Price ExxonMobil (NYSE: XOM ) 150 $86.87 $72.48 Chevron (NYSE: CVX ) 200 $106.62 $76.62 Royal Dutch Shell (NYSE: RDS.A ) 100 $62.16 $49.51 ConocoPhillips (NYSE: COP ) 100 $65.62 $47.19 Schlumberger Limited (NYSE: SLB ) 100 $92.69 $74.96 Phillips 66 (NYSE: PSX ) 100 $80.99 $77.20 Total S.A. (NYSE: TOT ) 430 $52.80 $44.11 Total Amount Invested: $99,894.50 Approximate Dividend Received: $971.00 Annual Dividend Income: $3884.95 Portfolio Cash: $14,578.45 Portfolio Discussion For those who are new to the realm of cyclical business, especially ones like oil where an oversupply of a few percent can cause a 50% drop in price, numbers like those seen above can be quite scary. However, it is worth pointing out that the numbers seen above solely exist because of the change in the price of oil. In fact, with the exception of the drop in oil prices, which has fallen approximately 20% since the last article, the fundamentals of none of the other companies has changed. In fact, the only thing that has changed fundamentally in the portfolio since the original article was the decision to sell Apache Corporation (NYSE: APA ). Apache Corporation is a strong corporation with solid potential, however, the thing I disliked about it is the fact that the majority of its assets are located in the United States. The goal of the portfolio is to form a broad portfolio of stable oil companies with exposure to a number of areas and Apache Corporation did not fit within that mandate. Purchases Now that we have discussed the changes in the portfolio, the portfolio now has $14,578.45 in cash sitting around. Recent factors have combined to make the perfect storm of oil prices. SSE Index Crash – Thomson Reuters The above image shows the Chinese SSE stock index. Partially due to a slowing economic growth rate and partially due to fear of a bubble, the Chinese stock index peaked around June before dropping sharply. As a major consumer of oil, fear of a decreasing Chinese growth rate has also hurt oil prices. This has been combined with recent ideas of a potential nuclear deal between the United States and Iran. Should Iran bring its production back online, that could result in a huge amount of new production that could cause a significant oil surplus. This money will be used to purchase 252 shares of the Lehman Aggregate Bond Fund (NYSEARCA: LAG ). The Lehman Aggregate Bond Fund invests in safe bonds with a modest dividend paid on a monthly basis. More so, the fund maintains a relatively solid price and remains a solid holding of cash for potential future purchasing opportunities. Future Market Situation Now that we have talked about the portfolio’s goals along with its holdings and discussed the portfolio along with its purchases, it is now time to talk about the true driver of this portfolio. The future market situation. Because in the end, it’s really oil prices that move this portfolio around. Annual Change in U.S. Crude Production – EIA The above image shows the change in U.S. crude production. Since 2008, as a result of growing shale production, American production has been steadily increasing. This surplus is what led to the current oil crash. However, in recent weeks, U.S. oil production has been steadily decreasing. The spending cuts are finally starting to have an affect and production is starting to decrease. This is starting to solve the overall oil supply. I expect the recent lows in oil production to potentially be tested again but I would be surprised if prices fall any distance below that. Production has started slowing down while demand, driven partly by lower prices, has continued increasing. This should help cause a recovery in oil prices. Conclusion The Big Oil Portfolio is made of a number of strong oil majors several of which have a long record of paying dividends. These companies have a strong dividend that they will be able to continue paying despite the recent slump in oil prices. However, decreasing economic growth in China coupled with the potential of higher oil production from Iran has caused oil prices to take a significant hit these past weeks which has also affected the portfolio. The portfolio does however have a good amount of cash in reserve should an opportunity present itself. This cash along with dividend growth should help support a recovery in the portfolio when prices eventually recover. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

VXX Benefiting From Backwardation, For Now

Summary VXX is benefiting from backwardation for now, we will discuss how long that might last. Historic contango and backwardation levels in relation to VIX futures. Your focus should remain on U.S. economics. First, thank you to everyone who shared or contributed to my 360 degree math classroom project . You guys are awesome! Let’s jump right in: Backwardation began on August 20th, 2015: (click to enlarge) As we discussed in the previous article , longer periods of backwardation will have positive effects on the ProShares Ultra VIX Short-term VIX Futures ETF (NYSEARCA: UVXY ) and the iPath S&P 500 VIX ST Futures ETN (NYSEARCA: VXX ). Popular inverse volatility products, such as the ProShares Short VIX Short-Term Futures (NYSEARCA: SVXY ) and the VelocityShares Daily Inverse VIX ST ETN (NASDAQ: XIV ) have been hammered during this period of backwardation and market head fakes: How long will this last? I believe this is the number one question at hand currently. Additionally, I believe there are two outcomes in the short-term. The Federal Reserve moves to raise rates providing a negative jolt to the market. The Federal Reserve moves to keep raise low, providing a short-term positive jolt to the market. I would personally view a delay in rate hikes as a negative on the U.S. economy. Eventually rates will rise and Wall Street has enjoyed easy money for a long time. The Fed has many things to take into account and I believe they are backed into several corners in regards to their inflation targets. To complicate this decision we have China and all of the talk about its slowing economy. I highly recommend this read by one of my favorite authors, Jeff Miller. I’ll be the first to admit that I really don’t know that much about China or its economy. I think Jeff does a good job of putting things into perspective. I also highly recommend his weekly Weighing the Week Ahead series. Economics If you have followed me for a significant amount of time, you know my feelings towards economics and the VIX. Short-term events are often not tied to economics, while longer-term VIX events are. This current event falls under the economic category and it is waiting on confirmation of a weakening economy. Whether the economy begins to weaken or not is now the question. This article isn’t to discuss the state of the U.S. economy but rather how potential changes could affect the VIX. For the most current economic data I like to us the investing.com economic calendar . Here is what you need to know: If negative economic conditions arise, even in light of a delayed rate hike, backwardation could persist for a much longer period of time. If positive economic conditions remain, than we will see a return to contango shortly, even in spite of short-term negative response to hike in rates. Current Advice Patience is needed now. If futures revert back to contango, I plan on initiating a short position in UVXY through options or purchasing XIV. This position will be small as futures could easily revert back to backwardation. For more on the contango and backwardation strategy, along with the backtesting results of this strategy, I recommend viewing my previous article here . Look below for the long-term back tested results of VXX: Chart created by Nathan Buehler using historical data from The Intelligent Investor Blog . The point of this graph is to demonstrate that the longest periods of time VXX has gone without losing value, is around one year. This is primarily due to the effects of backwardation just as contango has a long-term positive effect on XIV. For more information on what drives VXX, I recommend viewing this article . Chart created by Nathan Buehler using historical data from The Intelligent Investor Blog. To describe the above chart, the weighted future is the front and second month added together and divided by two. The best times to purchase inverse futures products or short long volatility products have come after prolonged periods of extreme backwardation. We are not going to see that type of event here unless U.S. economics begin to turn negative or show more negative signs than what is currently being reported. For now, I would continue to monitor the situation and keep a very close watch on the FOMC meeting coming up soon, economic reports out of China (and the rest of the world), and most importantly economic data here in the U.S. As a final thought, October is historically the most volatile month for volatility. Seasonality doesn’t always pan through so it is just something to ponder. Feel free to share your thoughts and comments below. The last article had over 160 comments and I really enjoy the conversations and learning that occurs when we can come together and discuss strategies, predictions, and outcomes in a professional setting. I hope you have a great week! Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in XIV over the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

IDU: This Utility ETF Looks Just Fine, Until You Compare It To VPU

Summary IDU offers exposure to a great sector, utilities, which is excellent for portfolio diversification. The ETF had about 61 holdings, which is fine until you consider that VPU has 83 and the expense ratio is less than a third as high. The largest exposure is to electric utilities, but the breakdown within the utility sector would be better if “multi-utilities” were broken down by source of revenue. As I’m looking over the possible ETF exposures, I’d like to evaluate several options for utility exposure. Utilities are often poorly represented in ETFs and that trend can even occur in ETFs focused on high dividend yields. That can be a shame because utilities are a nice holding for many investors since they provide high yields, moderate levels of volatility when used in a diversified portfolio, and they allow investors to own the producer of a major personal expense. Of course, the expense I’m talking about is the utility bills. So long as the investor is human (a safe assumption?) they are likely to be purchasing the services of one utility company or another. Even if the investor decides to retire in an apartment that includes utilities in the rent, a long term increase in utility costs could drive up rents. Some people may opt to live off the grid with solar power and drink their water from a well, but I’d wager that is a very small portion of my audience. One of the funds that I’m considering is the iShares U.S. Utilities ETF (NYSEARCA: IDU ). Expense Ratio Investors are already paying for the utilities flowing into their house and the utility companies are paying for their own management and infrastructure. It would seem very unfortunate if investors had to add another layer of costs onto their investment by having a high expense ratio. Unfortunately, that high expense ratio is present in IDU as the ETF reports an expense ratio of .43%. No, I don’t care for that expense ratio one bit. For comparison, the Vanguard Utilities ETF (NYSEARCA: VPU ) has an expense ratio of .12%. Can you guess which one I’d rather be paying? It shouldn’t be hard. Largest Holdings The following chart shows the top 25 holdings of IDU and their respective portion of the portfolio. The total portfolio only holds 61 companies, so this is a very substantial portion of the holdings. For comparison, VPU had 83 holdings. The holdings list is fairly standard. In short, the top 10 holdings are the same as the top 10 holdings for VPU and the top 8 are in the same order for each ETF. This appears to be a fairly standard utility ETF. Within the Sector The following chart classifies the holdings based on which part of the utility sector they fall into: I find this chart to be much more interesting than the one that simply breaks it down by company because this method shows at a glance what those companies are producing. There is one weakness to the presentation though because “Multi-Utilities” is not very specific and it represents over 34% of the portfolio. It would be great if the individual companies could be broken down by the portion of their revenue coming from electric, gas, and water services. Then those percentages could be aggregated back to the portfolio level and it would give investors a better feel for how well they could match their ownership of the producers with their own individual bills. From an investment level, that isn’t really necessary but it would be interesting to do and it might encourage investors to save more. Designing an intelligent portfolio structure is very important, but being engaged and making the choice to fund that portfolio is also very important. The biggest weakness I see for many young workers today is a lack of engagement in investing. Using a “hands off” strategy with allocating a large amount of money to Vanguard target date funds is a fine investment strategy. I believe it would outperform many individual investors, but it still relies on having enough engagement to actually follow through with funding the account. Building the Portfolio This hypothetical portfolio has a moderately aggressive allocation for the middle aged investor. Only 30% of the total portfolio value is placed in bonds and a third of that bond allocation is given to high yield bonds. This portfolio is probably taking on more risk than would be appropriate for many retiring investors since the volatility on equity can be so high. However, the diversification within the portfolio is fairly solid. Long term treasuries work nicely with major market indexes and I’ve designed this hypothetical portfolio without putting in the allocation I normally would for REITs on the assumption that the hypothetical portfolio is not going to be tax exempt. Hopefully investors will be keeping at least a material portion of their investment portfolio in tax advantaged accounts. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. (click to enlarge) A quick rundown of the portfolio The two bond funds in the portfolio are the PIMCO 0-5 Year High Yield Corporate Bond Index ETF (NYSEARCA: HYS ) for high yield shorter term debt and the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) for longer term treasury debt. TLT should be useful for the highly negative correlation it provides relative to the equity positions. HYS on the other hand is attempting to produce more current income with less duration risk by taking on some credit risk. The Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ) is used to make the portfolio overweight on consumer staples with a goal of providing more stability to the equity portion of the portfolio. is used to create a significant utility allocation for the portfolio to give it a higher dividend yield and help it produce more income. I find the utility sector often has some desirable risk characteristics that make it worth at least considering for an overweight representation in a portfolio. The iShares MSCI EAFE Small-Cap ETF (NYSEARCA: SCZ ) is used to provide some international diversification to the portfolio by giving it holdings in the foreign small-cap space. The core of the portfolio comes from simple exposure to the S&P 500 via the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ), though I would suggest that investors creating a new portfolio and not tied into an ETF for that large domestic position should consider the alternative by Vanguard’s Vanguard S&P 500 ETF (NYSEARCA: VOO ) which offers similar holdings and a lower expense ratio. I have yet to see any good argument for not using or another very similar fund as the core of a portfolio. In this piece I’m using SPY because some investors with a very long history of selling SPY may not want to trigger the capital gains tax on selling the position and thus choose to continue holding SPY rather than the alternatives with lower expense ratios. Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. Despite TLT being fairly volatile and tying SPY for the second highest volatility in the portfolio, it actually produces a negative risk contribution because it has a negative correlation with most of the portfolio. It is important to recognize that the “risk” on an investment needs to be considered in the context of the entire portfolio. To make it easier to analyze how risky each holding would be in the context of the portfolio, I have most of these holdings weighted at a simple 10%. Because of TLT’s heavy negative correlation, it receives a weighting of 20% and as the core of the portfolio SPY was weighted as 50%. Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio and with the S&P 500. Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. Conclusion IDU is offering investors exposure to the utility sector which can deserve being slightly overweight in a portfolio. For ETF investors, it may be hard to get enough utility exposure without specifically buying utility ETFs. From the perspective of risk in the portfolio it looks desirable to include IDU. The fund has only limited correlation and moderate volatility which makes it a nice fit. However, the presence of VPU offering more diversification and significantly lower expense ratios makes the use of IDU questionable. If investors had few ETF options, I would consider IDU superior to having poor diversification. Since investors have a plethora of choices for broad market exposure and even a few decent options for utility sector exposure, I’d rather avoid IDU in favor of VPU. More diversification in the holdings combined with a much lower expense ratio would make it fairly difficult for IDU to outperform VPU over the next twenty years unless there was either a material change in the expense ratios or in the holdings. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.