Tag Archives: USO

Top Movers in a Volatile Market

Street Insider.com lists some of the most active ETFs today.

At 2 pm:

iPath S&P 500 VIX Short-Term Futures ETN
(VXX) rose 8.37% to $28.30, on midday volume of 44 million shares, already four times more than its daily average volume. The ETF tracks the CBOE VIX, which is up 28.5% today to a near-term high of $42.15.

United States Natural Gas (UNG) gained 1.2% to $6.89 midafternoon on volume of 20.2 million vs. 26.8 daily average.

Utilities Select Sector SPDR (XLU) up 0.34% to $29.35, volume was already double the daily average at 10.6 million. People are moving to utilities for safety and dividends.

United States Oil (USO) fell 1.89% to $36.26 as crude oil futures posted steep losses for the fourth consecutive day. Mid-morning, the June 10 contracts hit an 11-week low near $74.50 a barrel, but were down $1.46 to $75.43 late afternoon. Volume was up 80% to 18 million.

Financial Select Sector SPDR
(XLF) was actually flat at 2 p.m. at $15.26. Volume had surged to 260 million from a daily average of 103 million. Goldman Sachs (GS) is up 1.7% to $144.65 in the wake of its annual shareholder meeting.

Hyland Calls Allegations “Gibberish”

Two of the most popular and least understood ETFs are the U.S. Oil Fund (USO) and the U.S. Natural Gas Fund (UNG). Many have blamed these funds for being partly responsible for excessive speculation that caused the surge in oil and gas prices.

In its effort to decide whether to impose limits on speculators in the energy markets, the Commodity Futures Trading Commission held three days of hearings in Washington.

John Hyland, the chief investment officer for both ETFs testified before the CFTC on Wednesday. Bloomberg gives a good overview of the testimony in which Hyland calls the allegation that his funds are responsible for rising prices “self-serving statistical gibberish.”

IndexUniverse offers the full transcript of Hyland’s testimony before the CFTC. In it Hyland rebutted the CFTC’s allegations by noting that there were only 325,000 investors in the fund and that between 75% and 90% were comprised of individual and retail investors, not institutions or investment funds. He added he believes the funds are widely held because no single investor has filed a 13G of 13F filing with the SEC. These filings are required of an investor holding an interest of more than 5% in a fund.

As for the charge by certain media outlets that the huge popularity of USO and UNG has caused prices to move artificially, Hyland fought back, saying “the management of USO believes that readily available information from USO’s website and other widely available financial news and data sources indicate that many or most of these claims lack merit.”

In February, the Wall Street Journal said USO had gotten so bit it was it’s affecting the oil market.

I followed the story with the following postings.

* Debating the WSJ’s Assessment of USO

* U.S. Oil to Change Roll Policy

* Suspected Front Running Cost USO $120 Million in February

And It Takes Two (Months) to Contango

Get Out of GM Now

This is the end, da, da, dum. Beautiful friend the end,” sang Jim Morrison in the Door’s classic elegy “The End.” Morrison named his band in honor of The Doors of Perception, a 1954 book by Aldous Huxley, describing Huxley’s trips on mescaline.

As the General Motors we know nears its end and the doors shut on some classic car brands, we have to reorient our perceptions about the company and its stock and its value.

Can you picture what will be
So limitless and free
Desperately in need…of some…strangers hand
In a…desperate land

All too often, investors who don’t understand the bankruptcy process buy shares of a company expected to go bankrupt in the misconception that if they buy now at a low price they can capture the upside when the company comes out of bankruptcy.

This is not the case. While General Motors may come back in some new form under the same name, the General Motors we know will soon be dead.

If a company doesn’t completely go out of business, it enters Chapter 11 bankruptcy. In this case the business is reorganized, instead of shutting down entirely. Still, in all forms of bankruptcy, the holders of common stock lose their entire investment in the company.

Everything.

Bond holders are creditors. They’ve lent capital to the company, so the company owes them money. The bankruptcy changes those obligations, but often creditors receive something for their loans, even if it’s just pennies on the dollar. Sometimes bondholders are given stock in the new company to give them a chance to make back some of their money. But current shareholders hardly ever get new stock.

Common stock holders are the company’s owners. They hold equity. Because their surrogates, the board of directors and executives, did a poor job of running their company, they lose their ownership stake completely. To make it clearer, if you hold common stock the day before the company emerges from bankruptcy you lose everything. While holding the stock to the bitter end may give you a better tax write off, if you sell now, you will at least pocket some cash.

So, please, please, don’t buy GM thinking you can hold it through the bankruptcy. All the current common shares will disappear the moment they emerge from bankruptcy. Can you make some day trades with GM and try to capture the spread? Sure, but since this is so close to the end, the risk is very high that they could call it a day on the day you are holding it and they you would lose your investment. If you haven’t already, get out of GM.

ETF Trends has an interesting piece on which ETFs will be affected by Obama’s Auto and Fuel Efficiency Plan.

United States Oil
(USO) and United States Gasoline (UGS) would be the ETFs most likely hurt from new fuel efficiency in cars. The PowerShares Wilderhill Clean Energy (PBW) would be a clear way to get in on the clean energy band wagon. ETFTrends also likes Vanguard Consumer Discretionary (VCR) saying consumers could do well if fuel efficiency lowers their gas bills. Finally, the E-TRACS UBS Long Platinum ETN (PTM) seems counter-intuitive. Platinum is used on catalytic converters. There should be fewer of these if the auto business goes through a contraction. However, the launch of a platinum ETF might spur heavy buying to fill the fund’s vaults. The ETN doesn’t actually hold platinum.

Suspected Front Running Cost USO $120 Million in February

The Wall Street Journal today reports that U.S. Oil (USO) has lost 20% of its value year-to-date, while the price of crude fell just 2.2%. The fund, which has grown from $7 million three years ago to $3.8 billion, is essentially losing money, and unable to track the crude oil market, because traders are front-running the roll. The roll is the movement from the first month contract that is soon to expire to the second month and soon-to-be front month contract.

Regulators are paying attention because it appears the fund is actually moving the market. Since U.S. Oil is so big and announces the day it will make the roll it appears speculators are making bets on these moves before they happen. The Journal says this is “adding to the costs of U.S. Oil’s roll and raising concerns among regulators that traders may be manipulating prices.”

“It’s like taking candy from a baby,” said Nauman Barakat, senior vice president at Macquarie Futures USA in New York, told the Journal. And this is hurting the fund’s investors.

The Journal reports that on the last roll, Feb. 6, U.S. Oil moved 80,000 contracts out of March into April. Thirty minutes before the New York Mercantile Exchange closed, the spread between the two month’s oil contracts jumped from $4 to $5.98, which cost the fund $120 million more than it would have a day earlier. At the same time, a trader could have pocketed $1,390 on each spread trade, which costs $810 to place.

The Journal says U.S. Oil complained to Nymex the following week. Last week, the Commodity Futures Trading Commission began investigating the trading.

U.S. Oil to Change Roll Policy

Aha! The Wall Street Journal obviously read my interview with John Hyland about its take on the U.S. Oil Fund’s (USO) influence on the futures market and is fighting back. Or did someone read my post and get to Hyland?

OK. I might be giving myself too much credit. But then again …

I’m not quite sure what to make of the fact that the day after I spoke with Hyland, the WSJ reported that the exchange-traded product with $3.4 billion in assets will abandon its practice of rolling its entire oil future position in one day. USO now says it will renew the expiring contracts over the course of four days.

The New York Mercantile Exchange says that last Tuesday USO held 19% of all the crude for April delivery. Meanwhile, the ICE Futures Europe exchange says the fund holds 30% of its April contracts.

The Journal says the size of the fund was affecting oil prices and hurting the fund’s investors. With the fund announcing what day it would roll, oil traders would front-run the fund by selling the front-month futures contract before that date. This would push the price down, hurting the fund’s investors. With oil for delivery currently higher than the spot price, USO would then need to pony up more to buy the second month contract.

WJS says “U.S. Oil paid anywhere from a $4 to $6.10-a-barrel premium when it sold March and bought April futures contracts, as robust oil supplies and weak demand pushed down near-term prices relative to outer months.” It also reported analysts at Goldman Sachs published a note saying long-term holdings in near-term commodity contracts are “not investable,” citing the large roll cost. According to WSJ, the USO’s share price had fallen 71% over the 52-weeks ending Wednesday.

USO said it will continue to hold the front-month contract, as that is the structure of the fund.

Debating the WSJ’s Assessment of USO

In a continuation of yesterday’s post, It Takes Two (Months) to Contango, I want to focus a little more on the roll. The roll is what an investor, or speculator, in the futures market needs to do to keep their investment open and avoid taking delivery of the commodity in question. Remember, futures are an obligation to buy or sell a commodity at a certain price on the day the contract expires. If you don’t close the futures contract before it expires, you can expect a big truck to unload 1,000 barrels of oil on your lawn in a few days. Unless you’re running an oil refinery, this is not a good move.

Before expiration, investors betting on a commodity need to sell the contract for next month and buy the contract for the second month out. When the first month expires, the second month contract, becomes the new first month contract. Yesterday’s post dealt with the cost involved with the roll and how when the price of oil is rising, a trend called “contango,” you will earn less than the total movement in the spot price of the commodity. However, unless you want to take delivery, this is the closest way to play the spot price.

Last week I highlighted an article in the Wall Street Journal. It said the U.S. Oil Fund (USO), the exchange-traded product that is a pure play on the first month oil futures contract, is getting so large it’s affecting the oil market. The Journal writer Carolyn Cui says the $3.3 billion in assets held by USO accounts for 22% of the outstanding front-month contracts. According to Cui the fund is so large that on the day it moved from the March to the April contract, Feb. 6, it had a visible affect on the oil market.

I called John Hyland, the portfolio manager of the U.S. Oil Fund, to get his take on this. Hyland says you can’t blame a huge one-day move solely on USO without looking at the trend three days before the roll and three days after.

“The people who look just at the day we roll and say the spread was “X”, that doesn’t tell you anything,” says Hyland. “You have to look at the days leading up to and the days after. You might miss the trend going on if you just look at USO.”

For instance, if the three days before the roll, the spread on the contract was $1 and the day of the roll the spread jumped to $2, then you can say there was an affect.

According to Hyland, the three days before Feb. 6, when USO rolled over its contract, the spread between the March and April contracts were $3.99, $3.87 and $3.88. The day USO rolled it jumped to $4.55. However, the next day the spread grew to $4.76 and over the next few days jumped to $4.81, $5.24 and $6.06, eventually widening to $8.19.

“The spread is tending to move wider as you get into the middle of the month, as March gets closer to expiration. Is that USO’s doing? How are we doing it after our roll?” asks Hyland. “It looks to me that as we get closer to expiration, it’s more of an inventory issue. The people who say it must be USO are not really looking at everything.”

Inventories are rising. If demand for oil drops off a million barrels a day and OPEC produces the same amount of oil, then inventory goes up million barrels a day. A lot of oil in the tanks is not bullish for the March contract. With supply rising and inventories hitting 52-week highs, one would expect the oil price to weaken. If OPEC cuts production, the shortfall will be made up from the current inventory. As inventories get smaller, the front month contract will stop trading at a big discount to the contracts further out.

People are assuming inventories will not build up indefinitely. OPEC will have to reduce production, if for no other reason than they will run out of storage tanks. Since the cheapest place to store oil is in the ground before you pump it out, they will cut production. At that time, inventories will start to shrink.

Market Folly, the blog posting I ragged on yesterday, actually has an interesting slide presentation from the International Energy Agency from November called The Era of Cheap Oil is Over. It’s a good read for anyone investing in oil.

It Takes Two (Months) to Contango

Caveat emptor.

It’s Latin for buyer beware. There’s no doubt that a lot of people in this world want to make money off of selling you junk. In fact, that’s a pretty good assessment of the entire collateral debt obligation market. If buyers had paid a little bit more attention to what they were buying, we might not be in the financial mess destroying the country.

ETF companies aren’t selling junk, but investors still need to be aware of what they’re buying. Many ETFs are extremely sophisticated instruments. Investors may think they are buying one thing, when in fact they are buying another. The problem isn’t with the ETFs. These transparent instruments lay it all out in the prospectus and usually in the easy-to-read fact sheet on their Web sites. The problem is investors need to do their homework.

For example, Tradefast, an independent equity trader at a private investment fund, writes on the MarketFolly blog about how contango affects the crude oil ETFs. He says “three factors play a role in determining the performance of the United States Oil Fund (USO): 1) changes in the spot price of crude oil, 2) interest income on un-invested cash, and 3) the ‘roll yield’.”

Unlike the two gold ETFs, the StreetTracks Gold Trust (GLD) and iShares COMEX Gold Trust (IAU), which actually hold gold bullion, USO doesn’t hold the underlying commodity, barrels of oil. It owns oil futures contracts.

While the spot price of crude oil, the price it costs to buy a barrel of oil today for immediate delivery, may affect how investors buy or sell this exchange-traded vehicle, USO doesn’t track the spot price. It holds holds the front month futures contract, which is where oil traders expect the price of oil to sell for a month from now.

So, while the spot price will influence where investors expect the price of oil to be a month from now, they don’t necessarily move together. For example on Friday, anticipation that passage the economic stimulus package going through Congress would increase demand for oil, the price of the March crude futures contract for West Texas Intermediate crude oil jumped $3.53, or 10.4%, to $37.51 a barrel on the New York Mercantile Exchange. Meanwhile, the spot price closed Friday with a bid/ask spread of $37.60 to $37.65, according to the Australian Associated Press.

USO investors hoping to capture the spot market’s Friday gain were surprised to see the ETP actually fall 1.2%. That’s because the previous Friday the fund had rolled out of the March contract and bought the April contract to avoid taking delivery of the actual oil this Friday. So, while the March contract jumped 10%, the NYMEX April crude contract fell 0.47% to $41.97.

It’s the forward roll from the first month contract (March) to the second, and future first, month contract (April) that upsets MarketFolly. When the price of oil is rising, it’s in a trend called “contango”. This means that demand for oil in the future is greater than today, or that future supplies will be tighter. So, when you sell the first month contract, you have to pay up to buy the next month’s contract. It’s not a straight line up like in a stock. If you sell the March contract at $37.50 and buy the April at $41.97, you have to pay an additional $4.47 per contract. This additional cost eats into returns. Well, with a little bit of research, such as reading this story I wrote for SmartMoney.com when USO launched three years ago, he wouldn’t have been so surprised.

MarketFolly then realizes that “USO is not a direct play on the spot price of crude oil – it is, instead, a play on the spot price, forward prices, and the relationship between spot and forward (the slop of the futures curve).”

Because of this he says that USO is not a good way for investors to play the price of oil. For some reason, the FT Alphaville blog from the Financial Times agrees with this ridiculous assertion. Since investors can’t buy the spot price of oil without taking delivery, you have to buy futures to make any kind of play on the price of oil. So, all investors pay the roll, not just USO. If investors were buying futures and not the ETP they would have to make the same kind of trades USO makes, pay the same cost of the forward roll, plus the transaction costs.

What Tradefast fails to realize is “being in contango doesn’t means you lose money,” says John Hyland, the portfolio manager of USO. “Being in contango means you underperform the spot price. If the price of oil rises $100 again, even in a contango market you still make money. You just make less that the return in spot, say $90. They just focused on one half of the equation.”

Hyland says in the reverse scenario, backwardation, when the price of oil in the second future month is lower than the near month contract, the investor would outperform the spot price, but that doesn’t mean you make money. “Spot can fall 50% and you fall 40%. So you outperformed the spot price, but you still lost money.”