Using ETFs To Track Oil Price: What's The Best Option?

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 |  Includes: DBO, OIL, USO
by: Michael Bommarito

I wanted to continue to take a look at the performance the standard oil ETFs. One of the conclusions I'd come to last time was that the daily correlation against the West Texas spot was a neck-to-neck tie between iPath GS Crude (NYSEARCA:OIL) and US Oil (NYSEARCA:USO), with the PowerShares (NYSEARCA:DBO) and Claymore (UCR) 5-15% behind.

Based on this data, I think it's clear that those wishing to trade ETFs as an alternative to the actual commodity should focus their attention on OIL and USO. Whether or not investors should favor these funds, however, is a different question, as daily correlation is not necessarily the best measure of hedge efficiency.

In order to do this, I've compared the difference between daily returns and difference between cumulative returns for these same funds against the West Texas spot price. This will give you an idea as to which is actually the best long-term investment if you're seeking an ETF oil hedge in your portfolio.

oil etfs

In the lower graph, it's pretty clear that stronger daily correlation is negatively correlated to performance against the spot. So while USO and OIL might give the best day-to-day correlation for trading, this comes at the cost of underperforming the actual underlying asset. UCR, though only 80% correlated on the day, actually seems to be able to outperform crude. You can see that this comes with a cost of volatility as usual, but given the asset allocation percentage that many currently justify for energy commodities, underperformance can be dangerous.

Looking at the top chart for daily return difference, it's also apparent that futures positions aren't just taking a hit at rollover. Though it's most noticeable then, OIL, USO, and DBO all have negative average differences even without the big spikes. So although we're only seeing one side of the futures-replicating-portfolio dilemma, it seems as if UCR is the best means for long-term hedging against crude prices.