Flirting With FRAK: An ETF For Believers In The Oil Rally

There are some certainties pertaining to oil and energy equities this year. The obvious include oil stocks and the relevant exchange traded funds have been drubbed on a year-to-date basis, but surprising as it may be to oil bears, the United States Oil Fund (NYSE: USO), which tracks front month West Texas Intermediate Futures, has entered a new bull market in just the past three trading days.

Time will tell whether oil's recent rally is the result of short covering or if fundamentals are legitimately shifting for the better. It is likely that situation sorts itself out sooner than later, but for traders looking to capture potential upside with previously moribund energy equities, exploration and production names are good spots to consider because that group has been savagely repudiated this year.

The Market Vectors Unconventional Oil & Gas ETF (NYSE: FRAK) is an ETF to consider for playing that theme. Exploration and production, or E&P, stocks have been taken to task this year, and last year for that matter, because these companies are more sensitive to oil price fluctuations than their integrated counterparts. That thesis has been borne out by FRAK, which has tumbled more than 23 percent year-to-date.

Large- and mega-cap integrated oil stocks have been less bad than their E&P peers because the definition of an integrated oil company means a company that has both upstream (E&P) operations and downstream (refining and marketing) businesses. Put simply, refiners have really been the only energy stocks worth being long this year. 

Predictably, it has been the smallest E&P names that have proven most vulnerable. However, FRAK skirts that situation because over 83 percent of the ETF's 66 holdings are considered large caps and the weighted average market value of those holdings is $19.6 billion, according to Market Vectors data. 

“Cash flow is at a premium and balance sheets are stretched for many companies. We believe it is important for companies to continue to push the edge on technology to help lower costs or to raise returns. However, if you have a stretched balance sheet and your cash flow is tight, you are likely not going to push the envelope on technology. You will likely continue to do exactly what you did yesterday and last year because you know it works and could provide a bridge to the next cycle,” said Shawn Reynolds, co-portfolio manager of Van Eck's Global Hard Assets Strategy, in a video posted by Van Eck, parent company of Market Vectors.

Cash is always important and that thesis bolsters the case for FRAK. Consider this: Occidental Petroleum Corp. (NYSE: OXY), FRAK's largest holding at 9.7 percent of the ETF's weight, had over $5.4 billion in cash on hand at the end of the first quarter and about two-thirds of that stockpile can only be used for buybacks, dividends or debt retirement.