Going Long and Short Oil

11/30/2009 10:00 am EST

Focus: ETFS

Doug Fabian

Editor, Successful ETF Investing, ETF Trader's Edge, Weekly ETF Report, and ETFU.com

Doug Fabian, editor of MakingMoneyAlert.com, lays out the bullish and bearish case for oil and tells how active investors can use leveraged ETFs to play them.

Oil recently made big news when crude soared higher than $80 per barrel. The question now for investors is whether this trend will continue.

The continued weakening of the US dollar could spur a mini-gusher for investors looking to profit from oil, [which] is among the commodities that tend to be inversely related to the strength of the US dollar. As the dollar dips, the price of oil rises. Indeed, the exploding US debt is putting downward pressure on the dollar, with no change of direction in sight.

Several indicators point towards oil prices continuing to rise in the foreseeable future. First, the futures market is signaling higher prices for oil and gas stocks during the coming months.

Second, the dollar keeps falling and putting upward pressure on the price of oil. Since oil is priced in dollars, foreigners can buy oil much more cheaply as the dollar drops. Third, as the US government takes on more debt, investors expect further depreciation of the dollar.

Also notable is the world's increase in energy consumption and demand. For example, China and India this year are expected to produce 11 million and 2.5 million cars, while auto sales in Brazil are estimated to have surged 20% in September alone. This increased production and consumption push oil prices higher, along with rising economic activity as the recession ends.

[Whether] you think that oil will soar in the future or if you believe that the dollar soon will recover and send the price of oil falling, an exchange traded fund (ETF) is available to meet your needs. Specifically, ProShares offers both leveraged long and short oil ETFs. (Editor’s Note: Leveraged ETFs are primarily trading vehicles, and only the most risk-tolerant investors should use them, preferably with stop losses.)

ProShares Ultra Oil & Gas (NYSEArca: DIG) seeks daily investment results, before fees and expenses, which correspond to twice (200%) the daily performance of the Dow Jones US Oil & Gas Index.

On the other hand, ProShares UltraShort Oil & Gas (NYSEArca: DUG) seeks daily investment results that correspond to twice (200%) the inverse (opposite) of the daily performance of the Dow Jones US Oil & Gas Index.

If the dollar starts to rise, investors may not need to use commodities such as oil as a hedge any longer, and that likely would push down the price of oil. This fund also might appeal to investors who believe that the worst of the recession may not be over, and that further economic problems lie ahead.

Also important for the prospects of this bearish fund is that oil is a scarce commodity. If oil production peaks, and a global climate deal is reached, alternative energy could serve as a substitute in the future. A global climate agreement could cut global crude demand by about four million barrels per day, forecasters estimate.

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