Don’t Buy USO or You will be BURIED alive!
Posted by Frugal on January 12th, 2007
Look at the two charts below (click to see the details). The first one is the actual crude oil spot price. The second one is USO.
Supposedly, USO should track crude oil spot price. However, since USO does so via futures contract, it is subjected to contango (future price higher than immediate delivery price, which will be UNfavorable to rolling over the contract) or backwardation (future price lower than immediate delivery, which will be favorable to rolling over the contract). You would expect that rolling these contract over would not be such a big deal. But apparently, market manipulation near the futures expiration dates have made USO a costly investment. If you calculate the price gap between USO and crude oil spot, you will discover that from 2004 to March of 2006, the gap of USO - $WTIC is about $4 (ranges from $2.56 to $5.5, but mostly near $4). However, something happened in 2006. The peak in $WTIC was almost $80, while USO was just $74.6, going from being higher than $4 to being lower than $5. And the story doesn’t end there. The gap kept getting worse. On Jan 8th, the gap has grown to negative $8.
I checked the NAV from the home page of USO, just to make sure that what I’m seeing is not due to stock symbol trading at a discount to NAV.
From USO home page, the current NAV or net asset value was 47.70 on Jan 8th 2007.
Even when I factor the management fee / expense ratio of 0.50% for this recent underperforming 1 year, that will only take out $0.37 from USO if I use their peak price of $74 to calculate the fee.
How do you account for this difference of $12 going from +4 to -8 gap to $WTIC? That is a huge 24% loss (using $50) coming from nowhere. I believe that the answers probably lie in the technicalities of rolling the futures contracts. In general, if you don’t take physical delivery of your commodity, you are subjected to market manipulation near the expiration dates. And I think that is what had happened to USO. Obviously, the managers at USO had no choices but to simply rolling over their contracts whenever they see fit or being forced to do so. They don’t have tanks to store these crude oils. I supposed that their hands were forced. Actually, I recall reading an article on financialsense that talks about crude being down $2+ on the date of expiration, while the next closest contract is still some $2+ higher (can’t find it, but it was in Nov or Dec rollover). Usually it would be the most cost-effective to roll over contracts on the last day so that you don’t incur extra time costs. But in the case that I just mentioned, USO would take up an immediate $2 loss on such rollover.
Crude oil is definitely the most political and the more manipulated market. It goes to show you again that taking your gold & silver bars home is probably the best bets. Counting on that the shorts in gold/silver market don’t go bankrupt may be too big of an assumption. Actually, they probably won’t go bankrupt, since they’ve got Bernanke behind their back. They probably just won’t have gold & silver for you, even when the futures contract states that they are obligated to deliver you such.
Do NOT buy USO! Any commodity funds that you buy better be backed by actual physical commodities. Paying storage fee is far better than being at the mercy of market manipulators.
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January 12th, 2007 at 8:38 am
I have USO on my yahoo widget and the ONLY reason I have it there is to get a quick glance on what oil might be trading at. I say “might” because early on in the creation of USO there were numerous articles written about the big gap (up to 10%) between the actual price of crude and the pricing of USO. Another article assumed that arbitrage players would come in and fill the gap to offset the difference. I had a wait and see attitude to see if this would be the case and it never materialized. I’ve noticed what you’ve graphically displayed for quite some time now which is why I stuck to trading XLE but I bailed on that when an article over at ETFInvestor.com illustrated that so much money had poured into Oil over the past quarter that the ship became top heavy and had to roll over.
January 12th, 2007 at 1:47 pm
It’s a coincidence that today financialsense just published an article exactly describing what I’m talking about here:
http://www.financialsense.com/fsu/editorials/2007/0112.html
Rolling over contracts (in USO) are simply not good for you.
January 12th, 2007 at 4:54 pm
Great insight, Frugal.
Much like Rich, I keep USO as the top ticker in my Yahoo! protfolio strip to get an idea of which direction oil is going for the day. Of course, it tells you NOTHING about how much it moves.
I’d stay away from USO too. If there were an oil ETF like GLD that tracked the commodity within a few pennies, it might be worth looking into.
Grant
January 13th, 2007 at 8:55 am
Interesting insight. So the question is: how do you play a pure “spot-price” crude play? I’d love to see a GLD equivalent for oil.
January 14th, 2007 at 2:34 am
Fin_Indie,
You MUST open a futures trading account. Manage your own rollover of contracts. Recently, I’ve seen at least two examples of terrible market manipulation near or on the days of expiration. Those are not the days that you want to roll your contracts over.
Instead of USO, may I suggest U.TO instead. It’s a holding for uranium. There is no GLD equivalent for oil unfortunately.
January 14th, 2007 at 11:11 pm
Hi First Million,
Sorry about that, but I don’t exactly see how the market manipulation is coming into the picture? Can you say a bit more about that?
Thanks,
James
January 15th, 2007 at 12:18 am
James,
Most of the time, the prices of anything should be kind of a continuous function, meaning that it changes, but one second after now, the price would be about the same. Well, what I have seen on expiration days on a different story.
Suppose a January futures contract expires this Friday, while February contract won’t expire for another month. You would think that the prices of the two contracts on the expiration date would be very close in price. The fact that Jan contract is expiring simply means that the price is the “spot” price, and since February is not so much further out, the price would be very close to January expiring contract.
Well, these market manipulators forced the Jan contracts down on the last day to their benefits. Similar to option trading, there can be an optimal price on the expiration day to render the total value of the call/put options to be minimal. So what happened was Jan contract would be trading at $58, while Feb would be trading at $60, which was simply too excessive.
Since the futures contracts may be expiring for USO ETF, they are forced to sell their Jan contract for $58, while rolling over to the next month at $60. For every contract that they roll over this way, they will need to eat up a $2 loss in the fund value.
I know for sure that such excessive spread happened in one of the months from October to December, and probably has happened very often to let USO lost some $10 in its fund value.
Here is another example. Tell me why would a “computer” sell for $500 this Friday, but will sell for $600 next Monday. Note that both $500 and $600 prices are available on Friday simultaneously (because different dated futures contracts are all actively traded), except that the condition for $500 price is that Friday is the last day. When a “vendor” like USO have expiring contracts to sell on Friday, USO will be killed to eat up the $100 price difference because they are forced to sell on Friday and can’t sell them next Monday.
Note, we are talking about crude oil!! What kind of difference does it make between any Friday and a Monday? Everyday, people drive, and refineries refined. A $2 price difference between the two dates are ridiculously manipulative.
January 15th, 2007 at 1:02 am
James,
I know most people would not believe in any manipulation theory. But there are even more examples. Stocks are routinely shorted to create phantom overhead supplies. It’s called fails to deliver. Check this article out:
http://www.financialsense.com/fsu/editorials/kirby/2006/1030.html
And here are the rules from SEC:
http://www.sec.gov/spotlight/keyregshoissues.htm
Without providing the fails statistics, these Wallstreet firms continue to manipulate the markets at will in stock markets, not to mention all other mechanisms in option and futures market.
And if you have ever read Ted Butler’s article on silver-investor and understand what he is talking about, you would take your silver home too. How in the world can these brokerage houses sell forward the entire annual silver production? If this continues, they might as well sell forward all the silver and gold in existence on earth, and pocket the interest money.
http://www.gold-eagle.com/gold_digest_00/butler030200.html
Such naked shorting is totally manipulative on the markets because it creates unfair and unsubstantiated supplies of silver or stocks. They are pretty much “making up” the market by creating phantom supplies.
So why is manipulation always about shorting? Because on the long side, the brokerage house’s ammunition is much more powerful. They can borrow incredible amount of money, and/or drive up the market either in the futures/option market, or in the actual stock market. Certainly, in the futures market, they will use the leverage up to 100X to achieve their purpose. In fact, with trillions of derivatives, I won’t be surprised that the leverage factor is more than 1000X.
January 29th, 2007 at 8:12 pm
Is this “USO” Scam legal?
January 31st, 2007 at 1:53 am
Yeah, it’s legal. Futures market robbing USO shareholders blindly.
October 26th, 2007 at 3:53 pm
USO does not reflect the future price of oil, like Frugal wrote. The most accurate 1-year forecast of the price of crude oil is on http://oil-price.net
Future contracts on which USO is based do not factor in a lot of things and are not a reliable indicator. The web site above on the other side forecasts the true price of oil.