Select Energy: Top ETF for 2012

Energy prices should find support from continued economic growth in 2012 and could spike higher if investors become even more skeptical of political stability in the Middle East.

Looking out a few years, other trends argue for higher stock prices in the U.S. For example, energy discovery and exploitation of petroleum and natural gas reserves in the U.S. is booming. Meanwhile, our favorite sector ETF for 2012 is SPDR Select Energy (XLE).

As long as current prices are sustained, unconventional reserves like oil sands, shale gas and deepwater wells can be developed and extracted profitably.
This is especially important for U.S. based producers, as much of North America�s remaining energy resources are locked in these kinds of �hard to extract�geologies.

At the same time, higher energy prices also benefit larger producers with lower-cost reserves, who stand to earn that much more profit. This is of particular benefit to XLE, of whose portfolio giants ExxonMobil and Chevron make up more than one-third.

Energy companies are aided in achieving such high profits by increasingly advanced seismic technology and extraction equipment, which have helped keep costs down on both conventional and unconventional reserves.

Nearly 20% of XLE is in oil equipment and services, including industry leader Schlumberger. Equipment and services stocks fell about 5% in 2011, a year in which the overall energy sector gained nearly 3%, as demand from abroad was weak.

However, burgeoning demand for new rigs and seismic testing in Western Canada and North Dakota has helped sustain operating performance in the industry, if not high stock prices.

XLE invests in the 44 energy stocks included the S&P500. Its total return in 2011 (2.8%) was a bit better than that of the S&P500 (up 1.9%), but its average valuation on estimated 2012 earnings is lower (price/earnings ratio of 10.8, vs. 12.8 for the index), reflecting investor worries about the sustainability of global growth.

We think this is an attractive entry point, considering prospects for increased global energy demand this year and beyond.