How Not to Get Burned By Commodity ETFs | ETF Trends

With any investment, you need to know the details of what you’re investing in. Just because a commodity exchange traded fund (ETF) is supposed to track the spot price of, say, oil doesn’t mean it will follow it. Over the past few years, many main street investors had to learn that the hard way.

Bloomberg News reports that a 68-year-old psychologist in Napa, California saw his nest egg shrink by 50% as his investments in stock and commodity ETFs soured during the recession.

Gordon Wolf – the psychologist- had expected commodities to offer a hedge against equity losses. Instead, everything fell in tandem.

But even as his portfolio dwindled, Wolf was certain that with oil at $34 a barrel, he was looking at an opportunity of a lifetime. So, he called his broker to buy him $10,000 worth of United States Oil Fund (NYSEArca: USO). [Are Oil Services ETFs Undervalued?]

Over the next month, Wolf watched as the price of oil rose 7.4% while USO fell by that same amount. Why the discrepancy?

The culprit was contango, a situation where the future price of a commodity is more expensive than a near-term one. [Understanding Contango.]

It works like this: When the futures contracts that commodity funds own are about to expire, they’re sold and replaced with new ones. If prices are in contango, then when they buy the more expensive contracts, they lose money.