It's official: Russian troops are now entering two eastern Ukraine breakaway regions, Donetsk and Luhansk. Oil prices are surging while markets are on edge on expectations of imminent, widespread sanctions from the West.
Russia is one of the world's largest suppliers of key energy commodities, including oil and natural gas as well as in-demand industrial metals such as aluminum, copper, cobalt, and nickel. With U.S. lawmakers promising the "mother of all sanctions" that would be "crippling to [the Russian] economy" in the event of an invasion, the markets are bracing themselves for a series of supply shocks that could trigger another round of price spikes.
Other than geopolitical tensions, investors have been flocking to oil and other commodities as inflation in the U.S. continues its northerly trajectory. Economic data showed that U.S. inflation has surged to a four-decade high of 7.5%, prompting the Federal Reserve Bank of St. Louis President James Bullard to advocate for a supersized rate hike. While equities declined on the day, oil is viewed as a safer bet amid rising cost pressures.
Here are five energy exchange-traded funds (ETFs) to hedge against inflation and geopolitical uncertainty.
#1. Energy Select Sector SPDR ETF
AUM: $34.7B
Expense Ratio: 0.10%
Dividend Yield (FWD): 4.1%
YTD Returns: 22.6% With nearly $35B in assets under management (AUM), the Energy Select Sector SPDR ETF (NYSEARCA:XLE) is the largest dedicated energy fund. It's also the most liquid and among the cheapest, with an expense ratio of just 0.10%.
XLE tracks the price and yield performance of companies in the Energy Select Sector Index. The index offers investors broad exposure to companies in the oil, gas, and energy equipment industries. Another key attraction: the ETF has a respectable 4.09% dividend yield (FWD).
Related: Oil Prices Temporarily Break $99 As Russian Troops Move Into Ukraine
One of its shortcomings, though, is that the ETF holds just 24 stocks in its portfolio, with ExxonMobil (NYSE:XOM) and Chevron Corp.(NYSE:CVX) over-represented, accounting for nearly 44% of the entire portfolio value.
#2. Vanguard Energy ETF
AUM: $6.63B
Expense Ratio: 0.10%
Dividend Yield (FWD): 4.0%
YTD Returns: 20.9%
Vanguard funds are traditionally known for undercutting the competition on costs, and the Vanguard Energy ETF (NYSEARCA:VDE) has remained true to this ethos by offering the lowest pricing in the sector. With 106 stocks--albeit with significantly less AUM than XLE-- VDE is much better diversified than XLE, though XOM and CVX still play outsized roles with weightings of 21.3% and 16.9%, respectively.
VDE tracks the performance of the MSCI US Investable Market Index (IMI)/Energy 25/50, an index consisting of stocks of large- and mid-cap US energy companies.
#3. United States Oil ETF, LP
AUM: $2.50B
Expense Ratio: 0.83%
Dividend Yield (FWD): N/A
YTD Returns: 19.1%
The United States Oil ETF, LP (NYSEARCA:USO) seeks to track the daily changes in percentage terms of the spot price of light, sweet crude oil delivered to Cushing, Oklahoma. USO invests primarily in futures contracts for light, sweet crude oil, other types of crude oil, diesel-heating oil, gasoline, natural gas, and other petroleum-based fuels.
Back in April 2020, USO gained notoriety last year after becoming the focus of the worst oil price crash in history.
WTI futures contract sunk an agonizing 310% to minus $38.45/barrel marking the first time that a futures contract for U.S. crude prices went negative--and made all those seemingly improbable 'negative oil' prognostications suddenly appear prescient. Negative oil prices are an absurd notion that essentially means that producers would pay traders to take the oil off their hands. USO, the country's largest long-only crude oil exchange-traded fund (ETF) was to blame for the debacle as it owned 25% of the outstanding volume of May WTI oil futures contracts.
Thankfully, a repeat of that kind of mayhem is unlikely after USO moved 20% of the WTI contracts it holds into later months in a bid to lower volatility.
#4. Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 2x Shares ETF
AUM: $874.9M
Expense Ratio: 1.14%
Dividend Yield (FWD): N/A
YTD Returns: 24.9%
The Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 2x Shares (NYSEARCA:GUSH) is an exchange traded fund that was launched by Direxion Investments in May 2015.
GUSH invests in public equity markets of the United States. The fund uses derivatives such as futures and swaps to create its portfolio and invests in growth and value stocks of companies across diversified market capitalization. It seeks to track 2x the daily performance of the S&P Oil & Gas Exploration & Production Select Industry Index (SPSIOP).
#5. iPath Series B Bloomberg Aluminum Subindex Total Return ETN
AUM: $15.61M
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Expense Ratio: 0.45%
Dividend Yield (FWD): N/A
YTD Returns: 17.1%
The iPath Series B Bloomberg Aluminum Subindex Total Return ETN (NYSEARCA:JJU) is an exchange traded note launched by Barclays Bank PLC in 2018. The note seeks to track the performance of the Bloomberg Aluminum Subindex Total Return. The index represents the commodity markets and comprises futures contracts on aluminum.
Exchange-traded notes (ETNs) are close cousins to exchange-traded funds (ETFs), but with some key structural differences.
ETNs different from ETFs in that they are unsecured debt securities that track an underlying index of securities, whereas ETFs provide investments into a fund that holds the assets it tracks, like stocks, bonds, or gold.
A big advantage that ETNs have over ETFs is that they come with no tracking error and also receive more favorable tax treatment.
On the flip side, an ETN like JJU comes with a credit risk because investors might lose their money in the unlikely event that Barclays goes under, whereas ETFs come with virtually no credit risk.
There's a solid reason to buy an aluminum ETN like JJU.
Russia accounts for ~6% of global aluminum supply, and an escalation of tensions between Russia and Ukraine raises the likelihood of a supply shock in an already tight aluminum market.
According to the U.S. Geological Survey, Russia made roughly 3.7 million metric tons of aluminum in 2021, with world production of the metal amounting to about 68 million metric tons. Data by CIA World Factbook shows that China is the world's biggest aluminum producer, making about 39 million metric tons in 2021, but Russia is also a large exporter of the commodity.
Aluminum prices have risen about 15% year to date, with prices near multiyear highs, but could still rise further. Jefferies analyst Christopher LaFemini says that even if geopolitical risks in Europe subside, aluminum prices probably will decline at first before rising again as the market deficit likely would persist.
Meanwhile, shares of one of the world's largest aluminum producers Alcoa Corp. (NYSE:AA) have jumped 270% over the past year and 31.3% YTD. LaFemina has raised his AA price target to a Street-high $90 from $75, good for 15% upside, while reiterating his Buy recommendation, as on escalating fears that reduced supplies from Russia.
By Alex Kimani for Oilprice.com
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