Popular oil ETF USO suspends new basket issuance amid distorted oil market

22 Apr, 2020 04:09
source: Singularity Financial

Singularity Financial Hong Kong April 21, 2020 – by David Lee

United States Oil Fund (USO) says on Tuesday (April 21),  US Commodity Funds (USCF) management is suspending ability of USO Authorized Purchasers to purchase new creation baskets. Stemming the fund’s growth may help trading in a futures market wracked by negative prices.

Retail investors who bought USO before the crash are suffering significant losses.

The United States Oil Fund (USO) fell more than 30% Tuesday following a more-than 10% drop Monday. The USO exchange-traded fund has plunged 75% in 2020.

The USO ETF controls nearly a third of the main oil-futures contract, as traders fear it too will fall into negative territory.

Retail investors conditioned by years of (mostly) being rewarded for buying the dips will become acquainted with that proverb as they absorb losses in a popular exchange-traded fund that allowed them to buy virtual barrels of crude. This time there could be collateral damage.

USCF management filed 8-K on Monday

In the Form 8-K filed on April 20, 2020 (“April 20 Form 8-K”), United States Oil Fund, LP (“USO”), indicated that it would announce through a current report on Form 8-K when USO has determined to temporarily suspend the issuance of additional Creation Baskets.

Today, USO issued all of its currently remaining registered shares. The registration statement that USO filed on April 20, 2020 with the Securities and Exchange Commission (“SEC”) to register an additional 4,000,000,000 shares has not been declared effective.

As a result, USCF management is suspending the ability of the USO Authorized Purchasers to purchase new creation baskets until such time as the new USO registration statement for the additional shares has been declared effective by the SEC.

The ability of Authorized Purchasers to redeem Redemption Baskets during the suspension of the sale of Creation Baskets will remain unaffected. In addition, trading of USO shares on the NYSE Arca, Inc. will not be discontinued as a result of the suspension of sales of Creation Baskets.

Investors don’t understand how USO works

According to John Davi, founder and CIO of Astoria Portfolio Advisors, USO is primarily owned by retail investors. But holding it is dangerous for those who believe they are betting on rising oil prices over time without fully understanding the dynamics of the commodity market.

David told CNBC, “To buy USO, you have to understand the oil futures market. They [retail investors] just buy the ETF because they think the price of crude will go up, but they don’t understand the drivers, which are fairly complicated.”

Many retail investors clearly don’t understand how USO works, or they wouldn’t invest in it. The U.S. oil ETF doesn’t track the WTI price, but the near-month futures contracts on WTI crude oil. That’s a big difference.

The oil ETF is traders’ best friend, but investors’ worst enemy. Traders can make big money by profiting from USO short-term price movements. But it’s not designed for long-term investors.

USO is good at tracking near-month oil futures but terrible at following spot oil over the long term. The reason why this ETF isn’t good at tracking oil’s spot price over the long-term is that it’s a huge pain to store crude–unlike, for example, gold or silver. It’s expensive and very dangerous. The “storage cost” is priced into the futures curve. As the contract nears expiration, USO must sell it and buy the next month out, which is usually more expensive.