Pouring Some Gasoline Into Your Portfolio

| About: The United (UGA)

Consider two energy traders. One owns a September 2012 RBOB gasoline futures contract. The other owns a September 2012 WTI crude oil contract.

As of around 10:30 am on August 15, the gasoline trader could sell his September contract for $3.02 per gallon and buy the October contract for $2.84, paying 18 cents less per gallon for the newer contract.

The crude oil trader could sell his September contract for $92.86 per barrel and buy the October contract for $93.20, paying 34 cents more per barrel for the newer contract.

Why? Gasoline is in backwardation, while WTI crude oil is in contango.

When energy prices go up, many traders turn to the US Oil Fund (NYSEARCA:USO). But the less popular US Gasoline Fund (NYSEARCA:UGA) might be the better choice. That's because both of these funds own futures contracts, which are continually rolled over. And if you own a fund like this, you'd rather see backwardation than contango.

Gasoline: More likely to be in backwardation

Contango means that the longer term contracts cost more than the nearer term contracts, so constantly rolling over contracts costs money. During backwardation those longer term contracts cost less, so a fund like UGA would benefit when rolling its contracts over.

Here's a chart that shows the contango in percentage terms for both gasoline and crude oil going back several years. Lines below the 0% level indicate backwardation.

Note that the backwardation for gasoline is now higher than it was just prior to the financial crisis. You can't say the same about WTI crude oil. (Although I will point out that another form of oil, Brent crude, is currently in backwardation).

Comparing ETF performance: Gasoline vs. WTI oil

Just because a commodity is in backwardation doesn't mean you'll automatically make money, of course. But with less contango pressure during certain time periods, it's easier for an ETF like UGA to perform better than for a fund like USO.

Take a look at how the US Gasoline ETF has behaved since 2008. I've showed the ETF, the spot price of gasoline, and the contango in this chart.

Now take a look at USO, WTI crude, and its contango.

The USO ETF has basically been range-bound for years, and to a great extent that's because WTI oil has been mostly in contango all those years. With UGA, there's a lot less contango pressure.

In my opinion, neither of these funds are suitable as the type of a long-term holding that you put in your portfolio and forget.

But over the short- to medium-term, if you're going to invest in energy ETFs that hold futures contracts, pick one like gasoline that follows a market in backwardation. That's usually going to be more profitable than one that follows a market in contango.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.