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  • Writer's pictureIshfaaq Peerally

US Oil Fund USO ETF Analysis

The US Oil Fund USO ETF $USO has been in the news lately as it had a reverse split and was accused of crashing oil prices $OIL . Is investing in the USO ETF the best way to have exposure to oil? Let's talk about the reverse split first and get over with it. It doesn't mean anything fundamentally. They merged 8 shares into 1 new share but the value of your investment in the ETF didn't change. The USO ETF like any other ETF is supposed to track a certain security. The GLD ETF for example tracks gold prices. In the case of the USO ETF, it failed to track oil prices since there is a big spread between the two. To understand why this is the case, we need to understand how oil is traded. Oil barrels are traded through futures contracts on the NYMEX (New York Mercantile Exchange). Usually oil producers make these oil futures contracts which allow them to sell oil at specific prices in the future. They do this in order to hedge themselves against volatilities in oil prices. These oil futures contracts are traded by oil traders. The oil traders don't need the oil to be delivered to them, so they are going to sell the contracts before expiration date. Right now, this is hard to do as there is a huge supply of oil not being used. We have entered a situation called a contango where long-term futures contracts are much more expensive than the short-term ones. A super contango is a bad thing for the USO ETF as they trade these contracts. Usually, the USO ETF would buy the front month contract and two weeks before it expires, they sell it to buy the one for next month. Now this is hard since the prices are so different. They are selling and buying these contracts at a loss. The USO ETF also took the decision to change their rules and instead of owning the front month contracts now, they own the long-term contracts. This further intensified the super contango and oil prices even went negative. The ETF completely changed their business model in days. If you look at the balance sheet of the USO ETF, you will see a lot of cash and bonds. The AUM of the ETF increased by 160% since the beginning of the year while the ETF lost 80% of its value. So, they are diluting the shares but we may be in a situation where there's no oil futures contract to buy anymore. What will they buy then? Keep cash? If you're buying the USO ETF, you're buying a piece of paper promising you that you can 'own' another piece of paper which will deliver oil to you a few months or years from now. You're not owning any real asset. I have worked out a simple scenario on my research partnership and you can see the same thing from historical data. If oil prices go up, you make less money on the USO ETF than buying physical oil and if the price goes down, you lose more money. It doesn't make sense investing in this ETF. We can expect oil prices to go higher in the future and the best way to win from this is to invest in oil companies, oil stocks. They own real oil, not some piece of paper. Watch the full video on YouTube and Subscribe: Here's the full analysis on my research partnership: Join my private investing group on Facebook for more:

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