NRGU Oil ETN: very attractive but volatile returns

Thesis

The BMO MicroSectors US Big Oil Index 3X Leveraged ETN (NRGU) is an exchange-traded note that aims to give an investor three times the daily return of the Solactive MicroSectors US Big Oil Index. Return is based on changes in the level of the index on a compounded daily basis, before fees are taken into account. The Index only has ten constituent companies, as we detail in the Securities section below. Accelerating inflation, corroborated by continued outbreaks of Covid variants, has set the stage for ever more volatile price action in the energy space, but within a well-defined uptrend. NRGU is a good vehicle to take advantage of temporary dips in energy markets for outsized returns. Already up 63% year-to-date, NRGU has a lot more room to operate in what some market participants are characterizing as a structural bull market in commodities. We are Bullish NRGU for 2022 with well-chosen entry points based on risky scenarios where we have seen energy markets take a beating, with the most recent event in December 2021.

Performance

The fund is up sharply in 2022 as more market participants shun tech stocks and turn to value and specifically energy:

As we can see on the year-to-date performance chart, NRGU has beaten both the Energy Select Sector Fund SPDR (XLE) and the S&P 500 Index (SPY), with NRGU up more than 63% while XLE is up “only” 16% and the S&P 500 is in the red for the year.

The vehicle is not a buy and hold vehicle as it experiences massive volatility due to its leveraged nature:

When we look at a 6-month chart, we can see that NRGU was up sharply before the December selloff driven by the emergence of the omicron variant. In December, NRGU retraced all of its earnings. The vehicle is volatile and the best trading strategy here is to pick a good entry point driven by a selloff in the energy market and have a 30-50% profit target in mind when you can get out. . This strategy would have made you a profit of 50% from September to the end of October and a savvy investor could have re-entered the same trade during the December Covid surge to gain another 50% in the following 4 weeks. NRGU is best traded over short periods and following volatile days in the energy market. I firmly believe that energy will outperform this year and that years of underinvestment in a “dirty” sector such as oil and gas will weigh on price growth going forward. A lack of Capex in a sector that needs continued investment to pump the same amount of oil every year will mean tighter production down the line, coupled with a delayed and costly transition to clean energy.

NRGU is not a vehicle for just any investor to use as it represents a very volatile and risky instrument, but used thoughtfully by a knowledgeable investor it can generate outsized results in a very short period of time.

NRGU metrics over a 3-year look-back period:

• Standard deviation: 141%
• Maximum reduction: -97%
• Sharpe ratio: 0.28

Assets

As shown above, the fund replicates the performance of the MicroSectors US Big Oil Index which has only ten components:

The ten components are generally large-cap energy companies that have seen significant upgrades from analysts in recent months:

Valero Energy (VLO):

* Barclays raised its price target for VLO

* Cowen raised its price target for the company

Chevron Corp (CVX):

* Wells raised its price target for CVX

Conclusion

NRGU is a leveraged ETN that provides exposure to ten major North American oil and gas companies. The vehicle has 3x leverage, making it a highly volatile instrument. However, the structural leverage coupled with the structural bull market in energy stocks offers very attractive returns if entry points are chosen carefully. We are Bullish NRGU for 2022 with well-chosen entry points based on risky scenarios where we have seen energy markets take a beating, with the most recent event in December 2021.