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Inching Into An Oil Dividend Strategy

Posted: Oct 23, 2008 13:19 PM by Gregory S. Davis

Tickers in this Article: DVY, CVY, DUG, DBO

Falling gas prices come as a relief to investors still coping with losses in their investment and retirement accounts. Figuring out the direction of oil prices might be better left to fortunetellers, but investors who stick with the principles of buying low should consider the following oil and dividend ETF strategy. (For more on ETFs, read 3 Steps To A Profitable ETF Portfolio.)

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Depressed Oil
The price for a barrel of oil has fallen from over $147 per barrel in July to below $72 per barrel on the futures markets in October. The American Automobile Association (AAA) reports that the national average for gasoline has followed suit by dropping from a high of $4.11 per gallon for regular unleaded gas on July 17 to $2.89 per gallon on October 21.

Long Oil
The PowerShares DB Oil Index (AMEX:DBO) has fallen only 13.77%, while oil prices have fallen more than 50% over the past three months. With a NAV near $29, this EFT allows investors to share in the upside potential of oil prices, while managing the risk of further declines in the price of oil. The PowerShares DB Oil Index gained more than 35% over the period starting January 2 until the height of gasoline prices on July 17.

Possible Hedge
OPEC has scheduled a meeting for Friday, October 24 in Vienna, Austria to consider oil production cuts in order to halt the downward momentum of oil prices. A decision to cut production could bolster oil prices, but ongoing fears of a slowdown in demand from the U.S. and China may have the opposite effect. An ETF that goes short (returns the inverse) against crude oil, like the ProShares UltraShort Oil & Gas (AMEX:DUG), might be a good component to add to an oil strategy as a downside hedge. The risk, however, is that the fund already has returned 23.20% since the beginning of the year.

Alternative Hedge
Investors could consider the Claymore Zacks Yield Hog (AMEX:CVY) to capture dividends while oil prices search for equilibrium. The CVY ETF is down 31.45% for the year, but it has a dividend yield of 7.61%. Another high yield ETF to evaluate is the iShares Dow Jones Dividend Select (AMEX:DVY), given its yield of 4.11%. An important difference between the CVY and the DVY is that the CVY has a 30.67% sector weighting in financials, while the DVY has nearly 47% weighting in the troubled sector. (To learn about sector rotation, read Sector Rotation: The Essentials.)

Patience
Guessing a bottom in a market can be just as painful as chasing winners that turn into losers. If you were considering an investment in oil, your best bet would be a dollar-cost averaging approach. Oil prices were as low as $48.20 in January of 2007. Since no one can really predict oil price highs and lows, investors should consider buying in increments as prices fall and use dividend-paying ETFs for additional downside protection.

By Gregory S. Davis

Gregory S. Davis is an investment writer and consultant for his company G.Davis Capital Inc. His core methodology for choosing investments include patience, diversification and asset due diligence. Gregory is a graduate of the Wharton School of Business. He is also a board member of StoriesWork, a non-profit organization based in Durham, NC that uses storytelling to empower youth and individuals to utilize alternative dispute resolution tactics.

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