The United States Oil Fund (NYSEArca: USO), which tracks West Texas Intermediate crude oil futures, has traded modestly higher over the past month, but those modest gains are not enough to fend off some traders with bearish views on oil’s near-term outlook.
Despite oil’s recent upside, the long oil trade as attracted plenty of naysayers. However, there are reasons for investors to be cautious with volatile energy ETFs. Moreover, if oil prices falls to new lows and the shale industry is unable to turn a profit, the highly leveraged industry may find it harder to repay debt obligations.
USO has been somewhat steady following a sharp reversal in September that forced a spate of short covering. A short position is a sale on a borrowed security. The investor needs to eventually return the borrowed stock by purchasing it back from the open market. If the price falls, the investor buys it back for less than he or she sold it for and pockets the profit. [Widening Contango Could Cut Into Popular Oil ETF’s Returns]
“Data from the CFTC’s (U.S. Commodity Futures Trading Commission) commitment of traders report Friday showed that managed money traders, which largely refers to hedge fund activity, showed some 27,694 short contracts were added last week. These are essentially traders taking bets that the price of oil will fall and compared to 7,073 long contracts that were added in the week ending October 27,” reports CNBC.
Investors should be careful of getting caught up in oil’s recent strength because the commodity is still in a bear market and expectations for a significant recovery are muted. Looking ahead, we may be in for low oil prices for much longer than many anticipated.
Specifically, USO tracks near month crude oil futures, swapping out contracts within two weeks of expiration for the next month contract. Consequently, in a contangoed market, USO would essentially be selling low and buying high, which may cut into performance. [Positioning for an Oil ETF Rebound? Watch For Contango.]
Alternatively, the PowerShares DB Oil Fund (NYSEArca: DBO) and United States 12 Month Oil Fund (NYSEArca: USL) provide exposure to WTI oil but include a different weighting methodology to limit the negative effects of contango. DBO can include contracts as far out as 13 months and dump contracts at any point. USL, on the other hand, ladders 12 months of contracts to diminish the effects of backwardation and contango.
“Hedge funds and other money managers had cut their gross short position in the key NYMEX WTI futures and options contract to 90 million barrels earlier in October. This was down from 108 million barrels at the start of last month and from the peak of 163 million barrels in early August, according to Reuters citing CFTC data,” reports CNBC.
United States Oil Fund
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.