Which ETFs Would Benefit From Lower Oil Prices?

by on July 2, 2010 | ETFs Mentioned:

Over the last several years, crude oil prices have taken investors on a wild ride. When the global economy was humming along, prices skyrocketed to a historic high of more than $140 per barrel. But from that peak, the downfall was both swift and severe; prices plummeted to almost $30 a barrel as economies around the world entered into a recession. From there prices surged again, more than doubling as markets recovered in the second half of 2009.

The volatility in energy markets has continued into 2010; crude prices have shown big swings this year, as a March sell-off took many investors by surprise. As the calendars turned to July, opinions over the next step for crude are all over the board. Some see $100 oil as a very real possibility, noting continued strong demand from emerging markets and the potential government interactions to drain supply from the market. Others think crude is likely to slide further, noting that weakness in the euro zone will weigh on demand for the commodity in coming months.

While lower prices may hurt some [see The Unlikely ETF Loser From Gulf Oil Spill], many have reaped the benefits of lower shipping costs, cheaper imports, and increased business from growing discretionary income. Lower crude prices may hurt oil companies, but it could be great news for consumers and other sectors of the market. Oil is a cost component for all types of businesses, meaning that the profitability of many industries maintain an inverse relationship with prices. And the average citizen simply notices cheaper prices at the pump, allowing them to spend their income elsewhere. The rise in discretionary income sparks hope for the retail and consumer discretionary sectors.

Thanks to the impressive rise of the ETF industry, there is no shortage of options for investors looking to make a bet on oil prices. There are more than a dozen ETFs in the Oil & Gas ETFdb Category and several more in the Energy Equities ETFdb Category. But there are also some less obvious potential beneficiaries from a dip in oil prices, including the five funds profiled below [for more actionable ETF ideas, sign up for our free ETF newsletter]:

Market Vectors Gaming ETF (BJK)

Van Eck’s BJK tracks the S-Network Global Gaming Index, a benchmark that provides exposure to publicly traded companies worldwide that derive more than 50% of revenues from the global gaming industry.Its top holdings include Las Vegas Sands (8%), International Game Technology (7%), and MGM Mirage (3%). This ETF invests roughly 65% of its assets overseas, with Australia and Malaysia coming in as the two highest international weightings. Notably, the ETF also allocates 20% of holdings to emerging markets. If oil prices dip in the second half, consumers could be left with a little extra cash burning a hole in their pockets. That could give a boost to a gaming sector that has been battered by significant cuts in discretionary spending in recent years [see BJK's technicals here]. BJK could make for an interesting play (no pun intended) if oil prices dip without a corresponding slide in discretionary income.

iPath DJ-UBS Livestock Total Return Sub-Index ETN (COW)

This cleverly-named ETN from iPath is linked to the Dow Jones-UBS Livestock Subindex Total Return, a benchmark that is currently composed of two livestock commodities contracts (lean hogs and live cattle) traded on U.S. exchanges. The fund breaks down quite simply, with 60% of its assets allocated to live cattle, and the other 40% invested in lean hogs [see more at COW's fact sheet]. If oil prices slide, households could have more room in their budgets for items like beef and pork, making COW a creative way to potentially play lower oil prices. COW charges an expense ratio of 0.75%.

iShares MSCI Japan Index Fund (EWJ)

This ETF tracks the MSCI Japan Index, a large cap-heavy benchmark that measures the performance of the Japanese equity market. EWJ top ten holdings consist of many well known names like Toyota, Honda, and even Nintendo [see all of EWJ's holdings here]. Japan’s economy is very export-dependent, meaning that high oil prices can jack up the costs associated with shipping products to overseas consumers. Lower oil prices, on the other hand, means lower shipping costs, which can lead to lower bottom line costs and increased demand. So in addition to saving a large fortune daily on its import prices (Japan is one of the world’s largest importers of crude oil), Japanese companies may benefit as well.

Claymore/NYSE Arca Airline ETF (FAA)

This one-of-a-kind airline fund tracks the NYSE Arca Global Airline Index, a modified equal-dollar weighted index designed to measure the performance of highly capitalized and liquid U.S. and international passenger airline companies identified as being in the airline industry and listed on developed and emerging global market exchanges. Its top holdings are made up of the most prominent airlines including United, Southwest, and Delta. As the past few years have demonstrated, fuel costs can be a killer in the airline industry [see FAA's performance charts here]. Ultra-low-cost airline Skybus operated for two years as the lowest cost and arguably the most unique airline in the country, giving away $10 seats on some of its flights. Skybus went under largely due to oil prices hitting an all time high, which was not anticipated upon the company’s inception. With cheaper fuel prices, expect airlines to become more profitable for as long as crude oil remains low.

HOLDRS Merrill Lynch Retail (RTH)

This retail HOLDR could make for an interesting play in times of low fuel costs. It holdings are made up entirely of consumer services firms with Wal-Mart (19%) and Home Depot (14%) topping the list. These are the kinds of companies that stand to gain from an increase in discretionary income [see RTH's fundamentals here]. If a slide in crude translates into a decline in prices at the pump–which is by no means a given–retailers could benefit.

Disclosure: No positions at time of writing.