Traditionally, there haven't been many options for U.S. investors wanting to take advantage of the Canadian oil sands. This changed when Claymore Securities introduced the Claymore SWM Canadian Energy Income ETF (AMEX: ENY) this July 2007.

What's in a Name?
Do not be fooled by the "energy income" part of the exchange-traded fund's (ETF) name, thought it does serve some merit.
Claymore included this phrase in the name because the ETF has the option of buying Canadian royalty trusts along with stocks related to the oil sands. The royalty trusts are best known for their large distribution payouts, often in the double-digits.

Due to Canadian tax regulations, the royalty trusts are able to pass along income to investors on a monthly basis, thus resulting in a large dividend yield. Late last year the Canadian government announced plans to repeal the special tax status for the royalty trusts and the sector immediately took a hit. Most have yet to recover.

Bull or Bear
The ETF methodology attempts to combine the most profitable and liquid Canadian royalty trusts with the most highly focused and fast growing oil-sands producers. The stocks eligible for inclusion in the ETF are traded in Canada and primarily the Toronto exchange.

Depending on the current trend of the price of crude oil (bullish or bearish), the ETF will use one of two allocation strategies. At the end of each calendar quarter the price of oil is determined, and if the closing price is above the four-quarter moving average price, crude oil is considered in a bullish trend according to the ETF. If the price is below the moving average, the trend is bearish. (For more on stock market wildlife see, Stock Basics: The Bulls, The Bears And The Farm.)

Once the trend is determined it allows the ETF's management to allocate the stocks on the first day of the calendar quarter. During a bullish trend 70% of the assets will be investing in the oil sands and 30% in the royalty trusts. The exact opposite will occur during a bearish phase.

At the end of the second quarter, the four-quarter moving average was approximately $65 and the price of oil was above $70. Therefore, Claymore would implement the bullish phase strategy and have 70% of the allocation invested in the oil sands. The same could have been said about last quarter; however, at the end of the fourth quarter of 2006, the price of crude would have been below the moving average.

O China
Canada has China to thank for the large amount of investment it poured into developing the oil sands over the years. The growing population and infrastructure in China is demanding more fossil fuels. With the price of oil near record levels and supplies not growing, it has made the heaviest users of energy think outside the box for supplies.

There is currently a pipeline under construction that will link the Alberta oil sands to the Pacific Coast for easy transport to China. And who do you think was an investor in the project? You guessed it, China.

Second Place Isn't Always Bad
Canada is the second largest country in the world in terms of land area; it is also is the second largest country in the world in terms of global proven oil reserves, behind Saudi Arabia. In 2006, the Alberta oil sands produced 1.2 million barrels per day and that number is expected to double over the next decade according to the Trends Magazine article "Oil Sands: The Near-Term Strategic Energy Solution". Not only will China continue to take advantage of the abundance of oil in Canada, but hopefully the United States decides to take advantage of its neighbor to the north.

I feel the demand for fossil fuels, oil in particular, will continue to rise over the next decade and that supply will be stagnant at best. Simple economics indicates rising demand plus unchanged supply will result in higher prices. Throw in the geopolitical wild card with Iraq and Iran and the price of oil could see $100 in the next few years.

Top Oil Sands Plays
Two of the three largest holdings of ENY are also traded in the United States as ADRs. Suncor Energy (NYSE:SU) and Imperial Oil (NYSE:IMO) are two stocks that have benefited greatly from their exposure to the oil sands as investors all over the world have been buying up shares. In the first six months of 2007, SU gained 14% and IMO was up an amazing 26%. Both stocks are currently sitting either at or near new all-time highs, and I believe there is room for more upside in the future.

Oil Sands vs. Royalty Trusts
Because my long-term view on the price of oil is bullish and I believe the Canadian oil sands will become more prevalent players in the market, it makes sense to favor buying ENY. However, the one concern is the tax implications the royalty trusts may run into in the next few years. There have been rumors that the Canadian government may be second guessing the tax changes planned for the royalty trusts in the next few years. In reality, the special tax treatment is scheduled to be removed and we must assume it will happen.

If oil were to stay in a bullish phase, then I would be comfortable holding the ETF. On the other hand if oil took a turn for the worse, 70% royalty trusts would not be an investment choice I would make. Therefore, I will give the new Canadian oil sands/royalty trust ETF a half thumbs up for now.

Looking to cook up a market-stomping stock portfolio? Check out our FREE report "7 Ingredients to Market Beating Stocks" and get started right now!

Related Articles
  1. Investing Basics

    Top Tips for Diversifying with Exotic Currencies

    Is there an opportunity in exotic currencies right now, or are you safer sticking to the major ones?
  2. Mutual Funds & ETFs

    The 3 Biggest Mutual Fund Companies in the US

    Compare and contrast the rise of America's big three institutional asset managers: BlackRock Funds, The Vanguard Group and State Street Global Advisors.
  3. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  4. Professionals

    5 Top-Rated Funds for Your Retirement Portfolio

    Mutual funds are a good choice for emotional investors. Here are five popular funds to consider.
  5. Investing News

    Are Stocks Cheap Now? Nope. And Here's Why

    Are stocks cheap right now? Be wary of those who are telling you what you want to hear. Here's why.
  6. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  7. Investing News

    These 3 High-Quality Stocks Are Dividend Royalty

    Here are three resilient, dividend-paying companies that may mitigate some worry in an uncertain investing environment.
  8. Stock Analysis

    An Auto Stock Alternative to Ford and GM

    If you're not sure where Ford and General Motors are going, you might want to look at this auto investment option instead.
  9. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  10. Chart Advisor

    Bumpy Roads Ahead In Transportation

    Investors are keeping an eye on the transportation industry. We'll take a look at the trend direction and how to trade it.
  1. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  2. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  3. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  4. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  5. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  6. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!