ETF’s have revolutionized the investment landscape. It’s given more people access to what used to be unobtainable, more diversification, and at a cheaper price. It’s no surprise ETF’s continue to dominate flows of funds from investors, now with 6,174 ETF listed. But’s here’s the thing. ETFs don’t work for every market and every investment style. Especially in commodity markets. The truth is, as much as we sometimes would like it to, the ETF structure just doesn’t jive with the structure of commodity markets. No market is a better example of why than everyone’s favorite commodity – Crude Oil. Here a brilliant and simple chart from Charlie Bilello – looking at the percentage gain of spot oil vs USO this year.
(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Charlie Bilello
The $3.3 Billion currently invested in $USO are missing out on roughly 26% (Disclaimer: Past performance is not necessarily indicative of future results) — just in the last eight months ! The reality is this chart doesn’t shock us, or anyone familiar with how futures markets work – with contract months, rolls, and so forth. Why this is happening is because the crude oil market is currently in Contango, meaning that further out futures contract of the oil market are priced higher than the current price, dragging down the ETF performance as they have to constantly move into the higher priced contracts to maintain exposure to the market (see here, and here for further explanation).
But while many people view this as a problem, using it as a way to paint the problems with ETFs – there’s some who view it as an opportunity. Nature abhors a vacuum, some physics teacher told us once – and the investing corollary is speculators love dislocations like this.
We’re thinking of one rather shrewd relative value commodities strategy who looks to profit off exactly this type of scenario, going both long and short Crude Oil in different contract months to take advantage of the differences in pricing on the ‘futures curve’, as they call it. That trader is up 15.40% YTD off the strategy (Disclaimer: Past performance is not necessarily indicative of future results), which looks somewhat similar to the amount of “loss” experienced by $USO investors. As the old poker saying goes, if you can’t spot the sucker at the table, you’re probably it. The USO “sucker” has been at it for quite a while, without realizing they are the sucker – which is fine by those trading the other side of this unique dislocation.