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May 2, 2020

Oil ETF's survival tactics embolden its swelling retail fan base

Bullish on oil and gold: Caldwell Investment CEO


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Warnings are blaring everywhere about the dangers of owning the U.S. Oil Fund, the star-crossed security for tracking crude. On Main Street, investors say they understand the risks and aren’t deterred by them.

The US$3.5-billion exchange-traded fund has been a hot spot for retail investors, who piled in as oil prices plunged amid an unprecedented supply glut. The ETF’s popularity with mom and pop fanned concern that individuals don’t understand the structure of USO, which tracks futures rather than just the price of oil. United States Commodity Funds LLC, the fund’s owner, was forced into a series of unusual actions as the crude market seized.

But 48-year-old Vaibhav Shukla says he knew exactly what he was getting into when he bought shares of USO last week after the price of May futures plunged to negative US$40 a barrel. Given that the ETF no longer invests in the front-month contract, Shukla used it to wager that demand for oil will snap back.

Another snag in the security’s wiring, its halting of share issuance, has caused the ETF to trade at a premium to its underlying value. That adds to the appeal of a long position, at least temporarily, Shukla said.

“Right now, USO, as well as crude, is dislocated. When it’s dislocated, there is an opportunity,” said London-based Shukla, whose main source of income comes from owning several technology companies. “Once it comes to normal, I might move to trading my futures rather than USO.”

Shulka, who spends three or four hours a day trading from his at-home battle station, is among the thousands of individuals who have poured money into the ETF in recent weeks. The number of investors at retail trading platform Robinhood holding it spiked above 220,000 this week, according to Robintrack, a website unaffiliated with the site that uses its data to show trends in positioning. That compares to 32,000 at the beginning of April.

USO has morphed into a much different product over that stretch. After years of tracking the front-month oil contract, the ETF rolled forward its holdings several times last week to longer-dated futures and warned it may see “significant tracking deviations” to its benchmark. On Monday, the issuer said it’s unclear if USO will ever be able to return to tracking the front-month contract.

Daniel Fernandez, a 30-year-old data scientist who lives in Pittsburgh, was among Robinhood’s newly minted USO holders. After watching the price of crude plummet, Fernandez searched for oil ETFs to express his view that May’s planned production cuts would fuel a rebound in the commodity. Last Thursday, he decided to buy shares of USO through his Robinhood account. However, he ended up selling those shares a few days later.

“I looked for an ETF with exposure to oil and this was the first that I found and it was the biggest one, so I thought it was a good one,” Fernandez said. “Then I kept researching and found this contango thing.”

After reading a Seeking Alpha article that described the perils of the futures roll when longer-dated contracts are more expensive than near-term ones, Fernandez decided he wanted exposure to futures that don’t expire anytime soon. He’s since bought shares of the United States 12 Month Oil Fund LP (USL), which contains further-out contracts. He’s also considering investing in the Invesco DB Oil Fund (DBO).

USO’s name recognition will continue to give it a leg-up in attracting flows, according to Bloomberg Intelligence. The ETF has pulled in nearly $6 billion this year, and hasn’t posted an outflow since April 7.

“I think most people just associate USO with oil,” said James Seyffart, a BI analyst. “It’s by far the largest and most-traded. I bet most people have no idea what USL or DBO are.”

USO climbed more than 12 per cent Wednesday and Thursday after executing its reverse split and as oil prices recover. It stumbled Friday, and even after the rally, the ETF still lost 8.2% in the week, and has lost over three-fourths of its value this year.

Still, that’s good news for 22-year old William Morton, who bought shares of USO at 3:58 p.m. on Monday for his personal portfolio. Morton — who qualifies as neither mom nor pop, given his job as an analyst at Citigroup — figured USO would make a good hedge for his holdings in oil tanker stocks such as Nordic American Tankers Ltd. And the issuer’s scramble to shore up the fund — which included repeatedly reshuffling its futures lineup and a 1-for-8 stock reverse share split — gave Morton confidence that USO wouldn’t go bust.

Also, the ETF had just plunged 15 per cent. Sensing a bottom, Morton clicked “buy” on his Schwab account.

“Some people are saying liquidation, but seeing they’re doing the reverse stock split and management’s doing everything they can to keep it alive, I didn’t think that was a possibility,” said San Francisco-based Morton, who’s currently sheltering-in-place in Philadelphia. “I probably wouldn’t have bought if I didn’t see that they’re in survival mode right now and doing everything they can to keep the ETF afloat.”

Shukla in London says USCF was prescient in moving USO’s portfolio away from the front-month contracts. S&P Dow Jones followed with a similar move on Monday, when it said it will roll all of its oil contracts for June into July. The index giant cited the risk that the nearer contract will go negative.

“People are beating them down for it, but what they did was they started detaching themselves from the front-month future much ahead of everybody else,” Shukla said. “Why would you want to track the front-month when it’s down 20 per cent and the rest of the curve is not?”