Global Uncertainty Helps Energy ETFs

NEW YORK ( Fabian Capital Management) -- With the global crisis in Syria seemingly heating up by the hour, the energy sector is thriving, based on the expectation of another regional conflict.

The price of oil just recently surged to a new overnight high of $112 a barrel and some experts are predicting that it could ultimately settle between $125 and $150.

This type of surge is not uncommon when geopolitical or socioeconomic uncertainty rears its ugly head. We saw a similar reaction in the energy markets in 2011 when the U.S. was engaged in keeping peace in Libya.

Not surprisingly, we are seeing a great deal of strength in ETFs that track the underlying price of crude oil, as well as energy stocks that stand to benefit from higher oil prices.

The United States Oil Fund ( USO), which tracks the daily price of light sweet crude, just hit new year-to-date highs and is now more than 27% above its April low. USO has benefited from strong demand and low oil inventories during the summer peak demand season, which led to higher energy prices.

Any type of retaliation or conflict in Syria could lead to a very rapid surge higher in USO, as well.

One of the largest ETFs that track energy stocks is the Energy Select Sector SPDR ( XLE). This ETF comprises 45 large-cap companies and is heavily weighted towards its three largest holdings, Exxon Mobil ( XOM), Chevron ( CVX) and Schlumberger ( SLB). Combined, those three stocks make up more than 37% of the fund's holdings.

Despite bouts of volatility, XLE has gained over 15% this year amid strength in oil prices. Probably the biggest worry for this ETF is the flagging performance of its largest holding, Exxon Mobil.

Exxon has failed to keep pace with the rest of the sector and is trying desperately to keep from slipping into negative territory for the year. The combination of the stock's being oversold and the Syria conflict has propped up Exxon's price for the time being, but it remains to be seen whether this stock will be able to regain momentum for the remainder of the year.

So how should you play the energy sector, given both the technical and fundamental factors at work?

Your Energy Sector Game Plan

If you believe that conflict with Syria is inevitable, then we will most likely see a continued surge in oil prices based on supply concerns. The easiest way to benefit from a surge in oil prices is to use an ETF that is directly correlated with crude, such as USO.

Nevertheless, new investors should be aware that USO is structured as a partnership to participate in purchasing commodities futures contracts. What this means to you is that any investor in the fund will receive a K-1 at the end of the year that will have to be dealt with on your tax return.

One way to avoid this headache is to consider using an exchange-traded note such as the iPath S&P GSCI Crude Oil ETN ( OIL). This fund tracks an index very similar to USO and will have comparable returns -- without the tax headache.

As for energy stocks, they may encounter more of a headwind if we see a conflict drag down the broader stock market as investors get skittish. Still, they will likely hold up better than other sectors if crude oil prices continue to remain strong.

No matter how you play this sector, I highly recommend that you consider using a stop loss on any new or existing positions to define your risk. There is still the potential for a great deal of volatility in this space that can't be ignored.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
David Fabian is currently a Managing Partner at Fabian Capital Management, a fee-only registered investment advisory firm specializing in exchange-traded funds. He has years of experience constructing actively managed growth and income portfolios using ETFs. David regularly contributes his views on wealth management in his company blog, podcasts, and special reports. Visit www.FabianCM.com to learn more.