Why Oil ETFs Are Lagging Oil Prices

Earlier this year, oil ETFs were lagging oil prices by a wide margin thanks to contango. Although the situation has improved, it brings to light a situation that futures-based commodity funds can experience.

In the last month, United States Oil Fund (NYSEArca: USO) has been lagging oil prices slightly: it’s up 10.4% in the last month, compared to about 10.7% for oil prices. PowerShares DB Oil (NYSEArca: DBO) is up about 10.2% in the same time period.

Contango, when the near-month contracts cost less than the contracts further out, can negatively impact futures-based ETFs because it makes buying new contracts more expensive. This is a situation the oil funds warn of in their prospectuses. The opposite of contango, backwardation, can benefit these funds. The markets spent about half of last year in backwardation.

Since about mid-2008, the oil markets have been in contago. Although they’re still there, the front-month contract is trading about 65 cents below the second month.

United States 12-Month Oil (NYSEArca: USL) can be an option when contango is in play. The fund invests in futures contracts over all 12 months instead of the near-month ones. USL is up 10% in the last month.

Comments

[Robert Mart...:]

Tom,
Great call. Contango is a directly observable event, and implies exactly what you recommend.
If we slip into backwardation, however, the USL would suffer vs. the USO. So investors should evaluate the shape of the futures curve before diving in.
For now, however, the upward slope in oil prices remains a headwind for USO holders every time that the front end month rolls over to a new, higher-priced month.
Rob

Nov 10 03:42 PM

[Johnni:]

Robert,

Yes the conclusion on that ETF or ETN to use for tracking Crude may well be conditional on backwardation or contango. However I argue that DBO currently is tracking Crude better than USO or USL.
See my blog: johnninielsen.wordpres.../

Nov 11 07:48 AM