Investors may want in on oil, but they'll have to find appropriate vehicles. Tom Sowanick is CIO of Clearbrook Research, part of Clearbrook Financial, a Princeton, N.J.-based third-party investment platform provider.

Investors are viewing crude oil's recent price drop as either an opportunity for a rebound or a missed chance to achieve broader diversification. This piece illustrates how certain investment vehicles are correlated with the price movement of crude oil. This information will allow investors to develop strategies that have the potential either to reduce the risk of shifting oil prices or to have more direct participation in the price movement of oil.

Crude oil prices have had some pronounced moves up and down over the past year. Between January 2006 and early August, West Texas Crude (WTI) rose from $65 a barrel to a peak of $80.39 a barrel, followed by a very sharp fall to a price of $50.60 on 19 January 2007.

Compare and contrast

Some investors prefer to select single stocks to gain exposure to oil. First, we compare the price sensitivity of Exxon Mobil to the price movement of WTI crude. Surprisingly, the correlation between WTI and Exxon has been very low, whether oil was rising or falling. When oil was rising, the correlation was only 0.21; when oil was falling, the correlation was only modestly higher at 0.36. So, investors selecting stocks like Exxon to gain exposure to oil may actually be under-exposed to oil.

Next, we examine the correlation between WTI and the XLE exchange-traded fund (ETF). The XLE is designed to provide investment results that correspond to the performance of the Energy Select Sector Index. The Index includes companies (large-cap focus) that develop and produce crude oil, natural gas, drilling and other energy-related services. In the same period mentioned above, we find the correlation between WTI and the XLE to be 0.39 when oil was rising and .41 when oil was falling, a slightly closer fit to the movement in crude than Exxon's stock offered.

Finally, we compare the price movement of WTI and the USO ETF, which tracks the price performance of WTI futures contracts. Here, the correlation is quite high at 0.93 when oil was rising and 0.92 when oil was falling.

Bottoming process

It is important that investors understand that oil stocks and energy-related ETFs offer differing levels of price exposure to the movement in crude. In some instances, investors may be under- or over-exposed to the price action for crude oil.

We believe that the price of crude is beginning a bottoming process. If this is the case, then establishing positions for the secular uptrend in commodities and crude should be considered at this point. Studies show that the investment cycle for commodities is approximately 15 years. We are now a third of the way through this cycle. From trough to peak, the Reuters/Jefferies CRB Index rose 83.6% (26 February 1999 to 28 April 2006) and has since had a correction of about 20%. Again, our view is that the secular uptrend is still intact and corrections should be purchased. -FWR

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