Oil ETFs: Cramer Discovers Contango, But Forgets History

By Matthew Hougan

Our good friend Jim Cramer went on a rant on Thursday night on Mad Money about the shortcomings on the United States Oil Fund (USO).

According to the digest at TheStreet.com:

"Cramer took aim at the United States Oil ETF in particular, calling the fund simply a travesty.

Cramer said the United States Oil Fund is not what it promises. The fund does not track the price of crude as it claims. Since the fund's [inception], crude oil has fallen 23%, yet the fund is down almost twice that at 54%. Just this year, oil is up 18%, but the United States Oil Fund is down 6%. This fund has nothing to do with oil at all, he said.

Cramer said the problem with the fund is that it doesn't buy oil, and instead buys oil futures. Since oil futures expire, the fund rolls over its contracts every month, incurring costs and expenses it'll never recover. Cramer said while the operations of the fund are legal, and listed in the [prospectus], investors need to steer clear at all costs."

As anyone who reads my blog knows, for better or worse, I've been writing extensively about the differences between USO, its sister fund USL and spot crude oil. As a general rule, I like that Cramer is at least talking about the fact that USO will not perfectly track the spot price of crude. That's an important message to get across.

The problem—as it always is with Cramer—is that the nuance is lost. USO is not a terrible investment. It is not a "travesty." It does what it says it does, which is invest in crude oil futures. By Cramer's argument, you would not want to invest in any commodity futures ETF, ever, because they don't track the spot price of commodities. That's crazy, considering the wealth of academic evidence supporting the use of commodities in asset allocation strategies.

The real problem with USO and other commodity ETFs is simply that many investors are not used to operating in the commodities market. We grew up on stocks and bonds. Now, the ETF market has opened up new markets like commodities and currencies to everyday investors for the first time ever, and we don't fully appreciate how they work.

As a result, people are surprised when USO doesn't track spot crude perfectly. They don't understand the influence of contango, backwardation and collateral return; they don't understand the tax treatment of commodity futures.

That speaks to the educational burden. It means people like me aren't doing enough to educate folks about the way these funds work. Because while it is a little complicated, it's not impossible. The information is at your fingertips. You can find out the level of contango in the oil market, for instance, by looking at the prices here. It just takes at least a little bit of work.

I did have one final thought for Cramer: Who really wants to own spot oil anyway? The spot price of oil has risen at a 2.5% annualized rate for the past 30 years. Over that stretch, futures have been a better bet by far.

Original post

Comments

[Bruce Vande...:]

Cramer says: "Just this year, oil is up 18%, but the United States Oil Fund is down 6%." This from a fund that is supposedly bullish on oil??? Cramer has a point.

The author says: "USO will not perfectly track the spot price of crude". This is kind of like saying an Alzheimer's patient doesn't have a perfect memory.

Any education on how futures based ETFs work is commendable. Someone, however, is making a lot of money. One person's "travesty" is another's profit.

Apr 05 08:55 AM

[jse17:]

Cramer, a nice enough guy, is currently running neck and neck with many other entertainment louts as the reigning, “Mr. Irrelevant!” At this pace, he will be back to writing Wills and Trusts before one can say, Booya!

Apr 05 09:02 AM

[Crude Oil T...:]

Cramer is obviously on TV to serve the retail investor. For that reason he should not even mention these types of ETF's. He knows that most retail investors are rushing out and buying stocks just because they come out of his mouth. USO like many other ETF's are meant to be, and are, great day trading tickers. People who do not understand the effects of slippage, expiration dates etc. need to stay clear of these.




crudeoiltrader.blogspo...

Apr 05 09:43 AM

[wise:]

A good posting because it is timely, relevent, and makes everyone think.

Apr 05 09:51 AM

[fran:]

we must always remember that cramer is first[and maybe only] an entertaner to keep attention focused on the product of CNBC--advertiseing. thus, he needs a scripted message with little dialogue or counterplay for the 5 or 10 minute time span. anyone baseing extensive investment decision process on this "entertainment while educating..." program is short sighted and short handed. especially when off target of "general STOCKmarket" focus-- in this instance, commodities.

looking historically at individual commodities or commodity indices might lead one to different conclusions or tradeoffs[backwardatio... being several important factors, as are secular vs cyclic drivers].

again--
always remember his main purpose, his scripted time limits and the message[DO THE HOMEWORK ON YOUR OWN].

don't you read or hear the warning given by CNBC with CRAMER'S broadcast appearances????

Apr 05 11:40 AM

[searcher:]

Every media personalty by definition has a persona that serves as their 'brand name'. Their world view is reflected in their presentation and garners an audience that in general shares that view. Thus you have 'right', 'left' and ?center? personas. Alternatively, but less frequently, a portion of the audience are in turn, amused or horrified by the 'drive by's' that arise. It's all about garnering and serving (pandering to?) their 'constituancy'. Very few, if any, of these 'giants' will ever make to even a footnote in future tomes on popular culture.

Apr 05 12:35 PM

[Dr. O:]

DBO has been doing a much better job of providing exposure to the upturn in oil. It's easy to do the comparative charting on Yahoo Finance.

With near month oil selling for less than far month oil (cantango), every time funds like USO seek merely to maintain their position in crude oil futures, they have to expend capital in the roll over process.

Apr 05 06:58 PM

[dcb:]

do you know if there is a way to find the rollover dates of the funds. I have heard rumor of raising futures before the roll over dates because you know the funds will have to buy en mass.


On Apr 05 06:58 PM Dr. O wrote:

> DBO has been doing a much better job of providing exposure to the
> upturn in oil. It's easy to do the comparative charting on Yahoo
> Finance.
>
> With near month oil selling for less than far month oil (cantango),
> every time funds like USO seek merely to maintain their position
> in crude oil futures, they have to expend capital in the roll over
> process.
>

Apr 05 09:24 PM

[mac.barron:]

The author, Mr. Hougan, states: "The problem—as it always is with Cramer—is that the nuance is lost."

Although I've never followed Mr. Cramer closely, the above assessment strikes me as a fairly accurate read on the situation. It also seems at least somewhat likely that, give his recent drubbing on The Daily Show, Mr. Cramer may be trying to build back some respectability for himself by calling out some investor pitfalls. Naturally, given his tendency towards oversimplification, it was easier to create the straw man of using a short term trading tool and re-branding it as an long term investment vehicle.

Apr 05 09:57 PM

[stnickb1:]

USO is neither bullish on oil nor bearish on oil. it tracks a commodity future of oil. Through an ETF it allows you to work an option in a stock like manner without purchasing put or calls in an options account. It allows more avenues to the average investor, however the average investor needs to educate themselves on futures. Bottom line you don't get A's without doing your homework!

Apr 05 11:49 PM

[Drew Arnold:]

Cramer's labeling the fund a "travesty" is certainly off, especially given his own investment strategies. How many times does he encourage people to "do their homework"? If investors do their homework on this fund, then they know what they were getting. If they're under the wrong impression as to what the fund is, then shouldn't Cramer recommend that they "do their homework" as opposed to calling the fund a travesty?

Apr 06 02:10 AM

[Chezfrederick:]

Everyone takes Cramer with a grain of salt... He is an entertainer and seeks levity. The fact that he pointed out the issues with USO however, is positive, and for the wide audience of uninformed, it raises a red flag. If one wants to track the spot price of oil, USO is not the means to do so yet many pundits seem to peddle it as the way to go... Most investors are not very well informed and I think any forun through which we can raise their awareness is positive...

I like Seeking Alpha because of this very reason, and I am encouraged that Cramer at least tried to be informative rather than funny. But I agree that he is usually very extreme in his description of the facts and conclusions and hence listeners miss the point.

Apr 06 07:24 AM

[rjt119:]

so does anyone have a better practical way of betting on oil?

Apr 06 07:50 AM

[jse17:]

One may wish to hold several of the CEFs or ETFs that follow albeit it not in perfect lock-step, oil prices. Paraphrasing, when oil explodes upward, all energy sources prosper enough to make direct relationships if not irrelevant, moot!

BGR, PEO, VDE, IXC (global oils), and XLE are a few of many that I follow. As “everyone’s best friend,” T. Boone Pick-your-pocket, states, “I am always long oil!” Additionally, PTR as a pure play is likely sound in that an ever more powerful 800 lb. gorilla is difficult to dispute! Buy a couple of issues and take a nap!

Apr 06 09:07 AM

[John Tandlich:]

What everyone fals to appreciate is that USO is a play on the roll yield for crude oil proces. In a period of contango where the spot price is lower than the price of oil in the future, USO will decline when expiring contracts are rolled into the following month.

USO works during periods of backwardation, when the spot price exceeds futures' prices. This occurs when demand for the commodity exceeds supply.

Apr 06 09:52 AM

[Sean Privitera:]

The thing about USO is that it was experiencing a disconnect because traders were gaming it based on its large scale rollover. Now that it is not rolling over in that fashion anymore it is harder to game it by shorting right before the roll over. Also, Jim leaves out the tax benefit received by holding the stock at year end (flow through loss on the K-1) because this stock is a partnership. So not only do you see a short term capital loss but you also see a loss from the partnership. USO is complicated but like you said, you can't really own physical oil so you are pretty much stuck with it. I am still a proponent of oil as you can see here:

seekingalpha.com/artic...

Apr 06 05:14 PM