Short Covering Helped Fuel This Energy ETF's Rebound

In what was a dreadful year for equity-based energy exchange-traded funds, the First Trust ISE Revere Natural Gas (ETF) FCG was a particularly poor performer in 2015, plunging 59.1 percent.

Although it has a long way to go even after last year's tumble, FCG is higher by more than 23 percent over the past three months, putting the ETF in a new bull market. One of the primary reasons behind FCG's rally, beyond rebounding oil prices, is short covering. As recently as late February, some of FCG's nearly 40 holdings were among the most shorted names in the energy sector.

The Benefits Of Sector-Wide Shorting

However, the sector's rapid rally has punished short sellers, forcing a wave of short covering that has driven some previously downtrodden names higher. Although no FCG holdings are currently among the most shorted energy names, the sector remains heavily shorted, indicating FCG could benefit from sector-wide short covering.

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“However, the recent rally has interrupted the relationship between conviction and subsequent price declines. The most in demand names in the US posted the second highest monthly rise in prices seen since 2009, jumping by 5.8 percent on an excess returns basis,” said Markit in a recent note. “This is only the third occasion where the top percentage of in demand names have posted a monthly excess return above 3 percent, in almost 10 years. On a year to date basis, the most in demand names are now in positive price performance territory.”

The ETF's Rebound

FCG's rebound is also accruing against a troubling backdrop of more high-yield energy defaults and bankruptcies within the sector.

“As of this week, there have been 59 U.S. oil and gas company bankruptcy filings since the price of crude oil began its steep decline in the second half of 2014, according to Reuters. Fifteen oil and gas companies filed for bankruptcy protection in Q1’16,” noted First Trust.

Interestingly, the energy sector's recent bounce has FCG looking expensive. The ETF's price-to-earnings ratio is nearly 39 with a price-to-book ratio of 1.64, according to issuer data.

“Not surprisingly, a quarter of names that make up the top 10 percent conviction shorts’ are energy firms, followed by 19 percent of names in the biotech sector,” added Markit.