USO ETF about to bankrupt itself. Retail investors who believed they were investing in crude oil get a rude awakening

Retail investors who believed they were investing in crude oil get a rude awakening

from the financial times:

Investors who have flooded into the oil markets to bet on a rebound in crude prices are risking big losses, say commodity specialists, as the exchange traded funds they use are swept up in the current market turmoil. The United States Oil fund, the largest oil ETF known as USO, saw inflows of about $1.5bn last week, as US crude prices hit their lowest levels since the early 2000s on plunging demand.

Professional traders said retail investors, in particular, were trying to pick the turning point for oil, betting that the market will recover quickly once coronavirus-fighting measures are eased. But prices had further to fall. On Monday, West Texas Intermediate, the US benchmark, crashed below zero for the first time in history, dropping as low as minus $40 as traders dumped the contract for delivery in May. The June contract, where most of USO’s investments currently sit, lost 15 per cent to about $21 a barrel.

Investors are not just at risk of placing a wrong-way bet, traders say, as oil contracts do not trade like equities. Instead, they expire monthly so the underlying crude can be delivered to buyers — something specialists fear could be poorly understood by greenhorn investors. “Investment in ETFs currently harbours high risks to investors who might be tempted to passively invest in oil due to ultra-low prices,” said Michel Salden, head of commodities at Vontobel Asset Management. Losses can occur when tracker funds have to “roll” their exposure when contracts expire, Mr Salden said.

If the oil market structure shifts into “contango” — an industry term for when spot prices are trading below contracts for future delivery — then an ETF might have to sell its contracts at the lower price, then buy the next month’s contract at a higher price just to maintain its holdings. Ole Hansen, Saxo Bank’s head of commodity strategy, said that the largest long-only oil ETFs had seen their net holdings rise by 400 per cent in the past month.

These ETFs, he warned, “are predominantly positioned at the front of the futures curve and will be exposed to rolling losses every month until the market fundamentals eventually stabilise”. That process “could take several months,” he added. USO was the fourth most actively traded ETF in the US on Monday morning, with more than half a billion dollars changing hands before lunchtime in New York, as the WTI spot price plummeted.

Investors’ move into USO is reminiscent of 2009, when many investors bought the ETF as crude prices slipped to near $30 a barrel, before almost tripling over the next 12 months as the world economy emerged from the depths of the financial crisis. Investors found their ETF returns did not match the oil-price gains, as they had lost a large chunk of their investment each month through the process of rolling contracts. The USO fund, launched in 2006, typically absorbs cash from investors when crude prices hit bottom. Inflows previously peaked in early 2009 and in early 2016, just after oil-price crashes. Since March, the number of shares outstanding in the fund has doubled as new cash comes in.