Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Overclockers UK Custom Built PC 1 YEAR Use Review Verdict - Does it Still Work? - 16th Oct 21
Altonville Mine Tours Maze at Alton Towers Scarefest 2021 - 16th Oct 21
How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
The Only way to Crush Inflation (not stocks) - 14th Oct 21
Why "Losses Are the Norm" in the Stock Market - 14th Oct 21
Sub Species Castle Maze at Alton Towers Scarefest 2021 - 14th Oct 21
Which Wallet is Best for Storing NFTs? - 14th Oct 21
Ailing UK Pound Has Global Effects - 14th Oct 21
How to Get 6 Years Life Out of Your Overclocked PC System, Optimum GPU, CPU and MB Performance - 13th Oct 21
The Demand Shock of 2022 - 12th Oct 21
4 Reasons Why NFTs Could Be The Future - 12th Oct 21
Crimex Silver: Murder Most Foul - 12th Oct 21
Bitcoin Rockets In Preparation For Liftoff To $100,000 - 12th Oct 21
INTEL Tech Stock to the MOON! INTC 2000 vs 2021 Market Bubble WARNING - 11th Oct 21
AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
Stock Market Wall of Worry Meets NFPs - 11th Oct 21
Stock Market Intermediate Correction Continues - 11th Oct 21
China / US Stock Markets Divergence - 10th Oct 21
Can US Save Taiwan From China? Taiwan Strait Naval Battle - PLA vs 7th Fleet War Game Simulation - 10th Oct 21
Gold Price Outlook: The Inflation Chasm Between Europe and the US - 10th Oct 21
US Real Estate ETFs React To Rising Housing Market Mortgage Interest Rates - 10th Oct 21
US China War over Taiwan Simulation 2021, Invasion Forecast - Who Will Win? - 9th Oct 21
When Will the Fed Taper? - 9th Oct 21
Dancing with Ghouls and Ghosts at Alton Towers Scarefest 2021 - 9th Oct 21
Stock Market FOMO Going into Crash Season - 8th Oct 21
Scan Computers - Custom Build PC 6 Months Later, Reliability, Issues, Quality of Tech Support Review - 8th Oct 21
Gold and Silver: Your Financial Main Battle Tanks - 8th Oct 21
How to handle the “Twin Crises” Evergrande and Debt Ceiling Threatening Stocks - 8th Oct 21
Why a Peak in US Home Prices May Be Approaching - 8th Oct 21
Alton Towers Scarefest is BACK! Post Pandemic Frights Begin, What it's Like to Enter Scarefest 2021 - 8th Oct 21
AJ Bell vs II Interactive Investor - Which Platform is Best for Buying US FAANG Stocks UK Investing - 7th Oct 21
Gold: Evergrande Investors' Savior - 7th Oct 21
Here's What Really Sets Interest Rates (Not Central Banks) - 7th Oct 21
CISCO 2020 Dot com Bubble Stock vs 2021 Bubble Tech Stocks Warning Analysis - 6th Oct 21
Precious Metals Complex Searching for a Bottom - 6th Oct 21
FB, AMZN, NFLX, GOOG, AAPL and FANG+ '5 Waves' Speaks Volumes - 6th Oct 21
Budgies Flying Ability 10 Weeks After wings Clipped, Flight Feathers Cut Grow Back - 6th Oct 21
Why Silver Price Could Crash by 20%! - 5th Oct 21
Will China's Crackdown Send Bitcoin's Price Tumbling? - 5th Oct 21
Natural Gas News: Europe Lacks Supply, So It Turns to Asia - 5th Oct 21
Stock Market Correction: One More Spark to Light the Fire? - 5th Oct 21
Fractal Design Meshify S2, Best PC Case Review, Build Quality, Airflow etc. - 5th Oct 21
Chasing Value with Five More Biotech Stocks for the Long-run - 4th Oct 21
Gold’s Century - While stocks dominated headlines, gold quietly performed - 4th Oct 21
NASDAQ Stock Market Head-n-Shoulders Warns Of Market Weakness – Critical Topping Pattern - 4th Oct 21
US Dollar on plan, attended by the Gold/Silver ratio - 4th Oct 21
Aptorum Group - APM - High RIsk Biotech Stocks Buy, Sell, Hold Investing Analysis for the Long-run - 3rd Oct 21
US Close to Hitting the Debt Ceiling: Gold Doesn’t Care - 3rd Oct 21
Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
Original Oculus VR HeadSet Rift Dev Kit v1 Before Facebook Bought Oculus - 3rd Oct 21
Microsoft Stock Valuation 2021 vs 2000 Bubble - Buy Sell or Hold Invest Analysis - 1st Oct 21
How to profit off the Acquisition spree in Fintech Stocks - 1st Oct 21
�� Halloween 2021 TESCO Shopping Before the Next Big Panic Buying! �� - 1st Oct 2
The Guide to Building a Design Portfolio Online - 1st Oct 21
BioDelivery Sciences International - BDSI - High RIsk Biotech Stocks Buy, Sell, Hold Investing Analysis for the Long-run - 30th Sep 21
America’s Revolving-Door Politics Behind the Fall of US-Sino Ties - 30th Sep 21
Dovish to Hawkish Fed: Sounds Bearish for Gold - 30th Sep 21
Stock Market Gauntlet to the Fed - 30th Sep 21
Should you include ESG investments in your portfolio? - 30th Sep 21
Takeda - TAK - High RIsk Biotech Stocks Buy, Sell, Hold Investing Analysis for the Long-run - 29th Sep 21
Stock Market Wishing Away Inflation - 29th Sep 21
Why Workers Are NOT Returning to Work as Lockdown's End - Wage Slaves Rebellion - 29th Sep 21
UK Fuel PANIC! Fighting at the Petrol Pumps! As Lemmings Create a New Crisis - 29th Sep 21
Gold Could See Tapering as Soon as November! - 29th Sep 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Oil Investors Are Doomed Even If Crude Oil Prices Recover

Companies / Oil Companies May 07, 2020 - 11:04 PM GMT

By: Stephen_McBride

Companies

I’m writing this essay because millions of investors are in danger without realizing it.

As you probably know, oil has recently taken an historic nosedive. On April 20, its price crashed from $18 a barrel to -$38, turning negative for the first time on record.

The news has set off an oil buying frenzy among Americans hoping to profit on a rebound.

In a matter of days, United States Oil Fund (USO), America’s most popular oil ETF, has exploded in popularity, as you can see below:


But most of these investors have made a terrible investment. There’s one simple reason that all but ensures funds like USO will never fully recover from today’s lows.

Even worse, it could get cut in half again! As I'll show you, it has to do with a legal requirement stipulated in the fund’s operating docs.

Yes, Oil Prices Will Eventually Rebound, and That's the Problem

As you know, COVID-19 has brought the world to a halt.

Ships aren’t sailing. Trucks and cars are parked. Planes are grounded. Most machines that use oil are sitting around unused in lockdowns sweeping the world.

But while oil taps are turned down to a trickle, oil producers keep pumping out a massive surplus of oil. So big, in fact, they are running out of space to store it.

It doesn’t take a genius to understand this can’t go on forever. As soon as the world goes back to “normal,” oil prices will perk up.

That’s what all those folks who own USO are banking on. Unfortunately, that’s not how it works.

Oil Funds Don’t Work the Way You May Think

Yes, oil funds like USO are designed to “track” the oil price. But it’s not as straightforward as it may sound.

Contrary to what most investors think, USO doesn't buy and store oil in massive tanks, which would be enormously expensive. Instead, it trades so-called "paper oil," also known as oil futures.

Oil futures are contracts that give you the right to buy physical oil at a predetermined price on a specific date in the future. (One contract represents 1,000 barrels of oil.)

You can trade them on the stock exchange like any other stock. The catch is: When these contracts expire, you have to pick up thousands of barrels of actual oil from the seller.

USO avoids taking delivery of physical oil by holding the futures contract until two weeks before its expiration. Then it sells it and buys another short-term contract in its place. For example, in the middle of March, it sells its April contract and buys a May contract.

This is not a secret. Page 18 of the fund’s “prospectus” warns investors that it will “roll” the contracts this way.

In normal times, this allows the fund to move in close lockstep with the oil price without having to own physical barrels of oil. But it all falls apart when it runs into a situation called “contango.”

The Dreaded “Contango” That Wreaks Havoc on Oil Funds

Take a look at the current prices of oil futures contracts until December 2020:


Source: RiskHedge

The December price is higher than July’s because the seller thinks oil demand will pick up by December, driving prices higher.

When commodity prices trend higher into the future like this, it’s called “contango.” This doesn’t happen often, but when it does, it wreaks havoc on funds built on futures like USO.

In the USO case, the fund has to swap most of its expiring futures with the nearest-month contracts. And since a future contract costs more than the one USO is holding, it in effect is forced to buy high and sell low.

For example, when oil was selling for -$38, the fund was essentially paying $22 a barrel. This way, they lose money on each trade.

Worse, now that the fund has attracted hundreds of thousands of new investors, it has to dump even more money into money-losing “contango” contracts. Every single month.

The Same Happened in 2008

Here’s proof of how “contango” wrecks oil funds like USO.

In 2008, oil bottomed out at $34. Then it recovered to $107 in the next four years, creating the very same “contango” situation we are in today:

Meanwhile, USO went sideways and never recovered, as you can see below:

There’s no reason to think this won’t happen this time around as oil prices pick up again. And I’m not the only one thinking this way.

USO Has Quietly Set off Alarm Bells

Last week, USO made a rare move called a “reverse split” that signals the fund is preparing for the worst. In short, it consolidated all its shares into fewer proportionally valued shares.

For example, before April 28, USO had 1.5 billion shares in circulation at $2.2. Today there are one eighth as many shares at 8X the price.

There’s no actual benefit in pulling this off except for one thing. Their management is afraid the fund’s shares would plunge below $1. And stock exchanges often delist stocks that trade below $1 to prevent price manipulation.

Let it sink in. The stock price was over $2 before the reverse split. That means USO insiders are worried the fund could plunge another 50% from today’s lows!

Meanwhile, investors are clutching at this ticking time bomb as if it's a surefire way to profit from rebounding oil prices. Don’t be one of them.

Written with the assistance of Dainius Runkevicius

The Great Disruptors: 3 Breakthrough Stocks Set to Double Your Money"
Get my latest report where I reveal my three favorite stocks that will hand you 100% gains as they disrupt whole industries. Get your free copy here.

By Stephen McBride

http://www.riskhedge.com

© 2020 Copyright Stephen McBride - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in