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The second of two periods of seasonal strength in the energy sector is approaching. The average optimal time is from July 24 to Oct. 3. Thackray's 2012 Investor's Guide notes that a trade in the S&P Energy Index has been profitable in 10 of the past 15 periods.

Annual recurring reasons for seasonal strength include strong demand for energy used for air conditioning and declining refined product inventories when refiners are converting their production from gasoline for the summer driving season to heating oil for the winter heating season. Added to this year's outlook is higher than average temperatures in North America this summer and forecasts for more of the same in August. In addition, U.S. heating oil and gasoline inventories already are at five-year lows, even before the annual conversion process begins to set the stage for significantly higher refined product prices this fall. Prices already have started to move higher. Since mid-June natural gas prices have jumped 42 per cent, wholesale gasoline prices have increased 16 per cent and heating oil prices have gained 16 per cent.

International events also could impact crude oil and refined product prices. Iran has threatened on several occasions to shut down the Straits of Hormuz in response to the West's growing sanctions designed to encourage curtailment of Iran's nuclear program. Most of the world's crude oil shipments exported from the Middle East must pass through the Straits of Hormuz.

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The Canadian energy sector could receive a boost this summer following news on Monday that China's CNOOC made a "friendly" cash offer to acquire Nexen for $15.1-billion (U.S.). The offer came at a 61 per cent premium to Nexen's closing price on Friday. The offer suggests that Canadian oil and gas producer stocks are undervalued and could prompt additional buying in the sector.

Ironically, energy equities and related ETFs have recorded only modest gains in July despite higher energy prices. Energy equities remain well below highs set in March and only began to outperform the S&P 500 Index and TSX Composite last week. Under-performance has been for good reason. West Texas Intermediate crude oil prices averaged $88 per barrel in the second quarter, down from $102 per barrel in the second quarter last year. Second-quarter earnings and cash flow will be down substantially on a year-over-year basis. Investors have been reluctant to own the sector prior to the release of "difficult" second-quarter results. The tip off will come this week when major Canadian and U.S. energy companies are scheduled to release results. If energy equity prices move higher despite bad news, the stage is set for a significant recovery by the sector into this fall.

On the charts, the sector on both sides of the border has an improving technical profile. The S&P Energy Index broke to a 10-week high on Friday, the Philadelphia Oil Services Index broke above a reverse head and shoulder pattern last week and the TSX Energy Index will complete a reverse head and shoulders pattern on a break above 245.05. The preferred strategy is to accumulate energy equities and related ETFs at current or lower prices for a seasonal trade lasting until October.

A wide variety of Exchange Traded Funds in the energy sector as well as crude oil, natural gas and gasoline are available in North American equity exchanges. U.S. exchanges list 30 Energy ETFs. Another 24 U.S. based ETFs trade oil, gasoline and natural gas. The most actively traded U.S. listed ETF is the Energy Select Sector SPDR. Canadian exchanges list seven energy equity ETFs and 11 oil and natural gas ETFs. The most actively traded Canadian equity ETF is iShares on the S&P/TSX Capped Energy Index.

Don Vialoux is the author of free daily reports on equity markets, sectors, commodities and Exchange Traded Funds. He is also a research analyst at Horizons Investment Management, offering research on Horizons Seasonal Rotation ETF (HAC-T). All of the views expressed herein are his personal views although they may be reflected in positions or transactions in the various client portfolios managed by Horizons Investment. Horizons Investment is the investment manager for the Horizons family of ETFs. Daily reports are available here.

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