The Best Way to Profit From Canadian Oil & Gas
by Dr. Kent Moors

Dear BRIAN MILLER,

Among the exchange-traded funds in our portfolio is the Guggenheim Canadian Energy Income ETF (NYSE: ENY).

Until recently, this fund was called the Claymore SWM Canadian Energy Income. But it was renamed on September 27, when Claymore Securities, Inc. changed its name to Guggenheim Funds Distributors, Inc. (The ticker symbols of their ETFs will remain the same.)

ENY, of course, was added to our portfolio to reflect oil and gas producers and field service companies operating in both conventional and unconventional projects in Canada. The latter category is where the main action is moving north of the border. The producing center remains the Western Canadian Sedimentary Basin (WCSB), where more than 97% of all Canadian gas and oil is produced.

But the makeup is rapidly changing...

The swing here from conventional (free-standing oil and gas) to unconventional (shale and tight gas, heavy oil and oil sands) has been dramatic. As the mature fields of free-standing oil and gas begin to deplete, the lost volume is more than compensated for by the new production coming on line from shale basins and oil sands.

WCSB production is based in Alberta, British Columbia and Saskatchewan. All three provinces have reformed tax systems to favor producers and increase their profitability. And with the rapidly increasing extractable reserve projections, especially for unconventional gas in British Columbia and Alberta, the race is on.

The Companies That Provide the Most Upside Potential

When production heats up like this, the problem for the individual investor has always been how to play it. This is especially the problem with the Canadian situation, since a rising amount of the new volume results from activities of medium- and smaller-sized companies. I currently track 77 of them in British Columbia and Alberta alone.

That total is up by six in only the last 10 days.

While many of the larger players will benefit, such as Encana (NYSE: ECA), Devon (NYSE: DVN), ExxonMobil (NYSE: XOM), Nexen (NYSE: NZY), EOG Resources (NYSE: EOG), Apache (NYSE: APA), the bulk of companies positioned to have the greatest up-tick are Canadian-traded only, most on the Toronto Stock Exchange (TSX).

Some of the "minnows" will become prime takeover targets (a prospect certain to bolster prices prior to the acquisition), while others will become successful niche producers with considerable upside potential. We are still at a stage too early to make such calls here in a sector that often has too little working capital or the ability to withstand prolonged delays in drilling. So what's required is a way to capture the direction in a manageable play.

This is where a well-structured ETF comes in.

The Perfect Play

There are two overall considerations in investing in the Canadian oil and gas market with an ETF.

First, the fund needs sufficient liquidity to offset disproportionate fluctuations resulting from small share-block moves. An ETF will carry some tracking discount to actual market operations in the full range of underlying stocks in any event. The lack of liquidity merely accentuates that problem.

Second, since this is Canada, one needs the ability to balance the actual impact of exchange-listed royalty trusts against individual company shares. The trusts provide the advantage of introducing liquidity into the mix, while, hopefully, the producers are providing the volume.

ENY fits these needs nicely. It measures the performance of the Sustainable Canadian Energy Income Index, a benchmark composed of about 30 TSX stocks. However, ENY has an approach unlike any other ETF. Selections are made from a universe that includes more than two dozen TSX-listed Canadian royalty trusts (reflecting a wide range of oil and gas producers) along with 20 oil sands companies classified as oil producers (that is, not as mining concerns), as well as a range of gas and oil field service companies.

The fund's goal is exactly what we are looking for.

As it notes in its prospectus, ENY seeks to "combine the most profitable and liquid Canadian royalty trusts with the most highly focused and fastest growing oil sands producers using a tactical asset allocation model based on the trend in crude oil prices."

So if the trend is perceived as higher, a greater weight is given to producers. And when the trend is seen as lower, ENY compensates with a greater reliance on the royalty trusts.

The use of a four-quarter rolling average to determine the division is a bit long for my taste (I am working on a series of indices of my own that will shorten the decision cycle). But the overall performance should be better than alternative approaches, at least in this initial stage of accelerating prices.

So if ENY is predicated on being able to respond to changes in crude oil pricing, has it been working?

Yes.

Although the fund has had a better daily percentage performance than the NYMEX in 52% of the 93 daily sessions since the Energy Advantage portfolio was released, that included two significant contractions where production issues were less the driving forces than other market-wide considerations.

But once the drive began for upward prices in an environment where returning demand is a greater factor, ENY performance has outdistanced the rise in NYMEX prices in 14 of the last 20 sessions (70%).

Looking for a greater trend line? Consider this: ENY daily session rolling monthly performance figures (adding the latest result and deleting the earliest) have outdistanced the equivalent NYMEX number in 10 of the last 11 sessions.

As the oil market heats up, we expect to see the Canadian production improve quicker than that of the U.S. for one basic reason. The collapse in pricing (September 2008 through the summer of 2009) hit companies operating in the WCSB much harder than in the states.



The Best Way to Profit From Canadian Oil & Gas
by Dr. Kent Moors

Dear BRIAN MILLER,

Among the exchange-traded funds in our portfolio is the Guggenheim Canadian Energy Income ETF (NYSE: ENY).

Until recently, this fund was called the Claymore SWM Canadian Energy Income. But it was renamed on September 27, when Claymore Securities, Inc. changed its name to Guggenheim Funds Distributors, Inc. (The ticker symbols of their ETFs will remain the same.)

ENY, of course, was added to our portfolio to reflect oil and gas producers and field service companies operating in both conventional and unconventional projects in Canada. The latter category is where the main action is moving north of the border. The producing center remains the Western Canadian Sedimentary Basin (WCSB), where more than 97% of all Canadian gas and oil is produced.

But the makeup is rapidly changing...

The swing here from conventional (free-standing oil and gas) to unconventional (shale and tight gas, heavy oil and oil sands) has been dramatic. As the mature fields of free-standing oil and gas begin to deplete, the lost volume is more than compensated for by the new production coming on line from shale basins and oil sands.

WCSB production is based in Alberta, British Columbia and Saskatchewan. All three provinces have reformed tax systems to favor producers and increase their profitability. And with the rapidly increasing extractable reserve projections, especially for unconventional gas in British Columbia and Alberta, the race is on.

The Companies That Provide the Most Upside Potential

When production heats up like this, the problem for the individual investor has always been how to play it. This is especially the problem with the Canadian situation, since a rising amount of the new volume results from activities of medium- and smaller-sized companies. I currently track 77 of them in British Columbia and Alberta alone.

That total is up by six in only the last 10 days.

While many of the larger players will benefit, such as Encana (NYSE: ECA), Devon (NYSE: DVN), ExxonMobil (NYSE: XOM), Nexen (NYSE: NZY), EOG Resources (NYSE: EOG), Apache (NYSE: APA), the bulk of companies positioned to have the greatest up-tick are Canadian-traded only, most on the Toronto Stock Exchange (TSX).

Some of the "minnows" will become prime takeover targets (a prospect certain to bolster prices prior to the acquisition), while others will become successful niche producers with considerable upside potential. We are still at a stage too early to make such calls here in a sector that often has too little working capital or the ability to withstand prolonged delays in drilling. So what's required is a way to capture the direction in a manageable play.

This is where a well-structured ETF comes in.

The Perfect Play

There are two overall considerations in investing in the Canadian oil and gas market with an ETF.

First, the fund needs sufficient liquidity to offset disproportionate fluctuations resulting from small share-block moves. An ETF will carry some tracking discount to actual market operations in the full range of underlying stocks in any event. The lack of liquidity merely accentuates that problem.

Second, since this is Canada, one needs the ability to balance the actual impact of exchange-listed royalty trusts against individual company shares. The trusts provide the advantage of introducing liquidity into the mix, while, hopefully, the producers are providing the volume.

ENY fits these needs nicely. It measures the performance of the Sustainable Canadian Energy Income Index, a benchmark composed of about 30 TSX stocks. However, ENY has an approach unlike any other ETF. Selections are made from a universe that includes more than two dozen TSX-listed Canadian royalty trusts (reflecting a wide range of oil and gas producers) along with 20 oil sands companies classified as oil producers (that is, not as mining concerns), as well as a range of gas and oil field service companies.

The fund's goal is exactly what we are looking for.

As it notes in its prospectus, ENY seeks to "combine the most profitable and liquid Canadian royalty trusts with the most highly focused and fastest growing oil sands producers using a tactical asset allocation model based on the trend in crude oil prices."

So if the trend is perceived as higher, a greater weight is given to producers. And when the trend is seen as lower, ENY compensates with a greater reliance on the royalty trusts.

The use of a four-quarter rolling average to determine the division is a bit long for my taste (I am working on a series of indices of my own that will shorten the decision cycle). But the overall performance should be better than alternative approaches, at least in this initial stage of accelerating prices.

So if ENY is predicated on being able to respond to changes in crude oil pricing, has it been working?

Yes.

Although the fund has had a better daily percentage performance than the NYMEX in 52% of the 93 daily sessions since the Energy Advantage portfolio was released, that included two significant contractions where production issues were less the driving forces than other market-wide considerations.

But once the drive began for upward prices in an environment where returning demand is a greater factor, ENY performance has outdistanced the rise in NYMEX prices in 14 of the last 20 sessions (70%).

Looking for a greater trend line? Consider this: ENY daily session rolling monthly performance figures (adding the latest result and deleting the earliest) have outdistanced the equivalent NYMEX number in 10 of the last 11 sessions.

As the oil market heats up, we expect to see the Canadian production improve quicker than that of the U.S. for one basic reason. The collapse in pricing (September 2008 through the summer of 2009) hit companies operating in the WCSB much harder than in the states.