ETF Expert

Some moviegoers may recall Ashton Kutcher in the "Butterfly Effect." In essence, minor and apparently inconsequential actions in the past had radical effects on the main character’s present life.

Put another way, if a butterfly’s wings are flapping near a Nigerian pipeline, worldwide oil prices may jump 5% in a single trading session. Or if a tropical storm heads into the Gulf of Mexico, crude oil futures may hit $150+ before the blink of a hurricane’s eye.

The chatter from many analysts of the oil crisis say that "it’s different this time." Oil can only go up, most suggest. (Keep in mind, few analysts beyond T. Boone Pickens called $100+ per barrel one year ago.)

So what’s really happening? After all, huge increases in demand from emerging and developed markets, alongside supply difficulties, account for crude in the $70 per barrel range. Only a weak dollar and speculation have driven the rest. (See "We’re Running Out of Oil" Causes June Gloom.")

As I pointed out a few weeks ago, however, the U.S. dollar is essentially firming up since the last Fed rate cut on April 30. That leaves speculation.

Hedge funds are still looking to win going long during peak usage in the summertime. Individuals with access to ETFs like the United States Oil Trust (USO) see few other places to profit in a recessionary environment. Even commercial users of the commodity are fearful that… if they don’t lock in these high prices… they’ll be left in the doldrums if prices climb further. (Californians remember that this fear cost Gray Davis his governorship to Arnold, but I digress.)

Yet speculation has a way of turning on a dime. Even without an obvious catalyst for why the oil bubble will eventually prick, something will happen. Call it the "Reverse Butterfly Effect."

Remember, in the 80s and 90s, oil barely budged when problems in Nigeria occurred or when hurricanes hit oil rigs. Today’s hypersensitivity in oil trading ignores a number of realities, including the possibility of new drilling in the U.S., the importing that we do from Canada and Mexico, as well as alternative energy development. In other words, the unprecedented volatility of oil (record price swings) cannot continue indefinitely.

I am not suggesting that the irrational exuberance of crude-only investing can’t push the "per barrel" to $150 or $200. What I am suggesting is that the current volatility makes the risk-reward for being in oil alone a poor decision. Stick with my long-time favorite, the Dow Jones AIG Commodity Index (DJP).

At some point, oil will go down. When few seemed to believe that housing demand would slow, it screeched to a halt. When few believed we could possibly provide enough supply of homes, builders overbuilt. The rest is history. (And quite frankly, the same thing happened with tech company shares in the Nasdaq bubble of 2000.)

But even if you do not believe that oil will go down in dramatic fashion, do you really want to be part of the herd betting on rising oil prices? What about an area where a small group of qualified suppliers are responding to a genuine increase in demand… the demand for alternative energy?

Here are a number worthy of discussion:

1. PowerShares WilderHill Clean Energy (PBW). Call it the original… this exchange-traded fund invests in stocks of companies engaged in the business of conservation and/or advancing cleaner energy solutions. It would be hard not to characterize the trading on PBW as somewhat erratic since its introduction in 2005. Nevertheless, it remains a premier possibility for simple access to the space.

2. PowerShares Global Clean Energy Fund (PBD). This one is comprised of mid-sized growth-oriented corporations. Each focuses on renewable sources of energy and/or technologies that will facilitate cleaner energy. The benefit here is that it is diversified clear across the globe. Some would argue against its lofty P/E, yet the return on equity is near an enviable 15%!

3. Market Vectors Global Nuclear Energy (NLR). When it comes to alternative energy, the space is not narrowly defined by the energy required to move our vehicles. Electricity is one of the largest in-demand items around the globe. Most importantly, the emerging and developed nations worldwide are quickly gravitating towards nuclear power. (Read "Nuclear Energy ETFs: 3 Reasons for a Rebound.")

4. Claymore Global Solar Energy (TAN). Plenty of analysts see the power in companies like First Solar (FSLR) and SunPower (SPWR). In fact, a Lehman analyst upped his price target on FSLR today. However, if you’d like to get a basket of 25 of the top small, mid-sized and large companies in solar, this is one way to do it.

5. First Trust Global Wind Energy (FAN). 50 companies, 18 domestic. This one’s truly a global player. However, it just began trading this month. Granted, the backdated performance of nearly 70% returns in 2007 may make you salivate, but it’s not yet clear whether the wind will blow favorably for wind investors going forward.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.