USO is ‘broken’ right now: ETF Expert

The biggest oil ETF plunges more than 30% this week amid the coronavirus. Yahoo Finance’s Seana Smith and ETF Trends Director of Research Dave Nadig discuss.

Video Transcript

SEANA SMITH: Now it's time for an ETF report brought to you by Invesco. We want to focus on the United States oil fund, ticker symbol USO. Now this comes as we see a little bit of a rebound in the price of oil today after that historic-- the historic losses that we saw to start the week.

So oil today settling up 19% at $13.78 a barrel. And for more on this, for more on the recent moves that we've seen in energy and across oil, I want to bring in Dave Nadig, ETF Trends director of research.

And Dave, let's focus on not only what we've seen in crude but drill down into the ETF USO. Now, it's an extremely popular ETF with many retail investors. It tracks the price of oil. After that historic plunge that we got in oil earlier this week, how badly, I guess, are retail investors getting burned by this ETF at this point?

DAVE NADIG: Yeah, I mean, this is-- we have a weird situation, right? We obviously have unprecedented markets in oil. You know, I'm sure you guys have been covering the massive oversupply at the Oklahoma pipelines. And the USO ETF invests in-- it's supposed to invest in the front month futures.

There's been so much demand for this ETF, however-- really just in the last two weeks, we've had $2 billion of new money flow in-- that it actually can't own those front month futures anymore, which would be the June futures, because they'd position limit.

So they've actually had to change the strategy of the fund in response to the amount of money they've pulled in. And, at the same time, they've actually run out of shares to issue, so they're not able to create new shares to meet demand.

That means it's been trading actually at a premium to what is already a fairly low oil price, for sure. So it's a little bit of a broken ETF right now, and it's one that investors should probably be avoiding, at least until we get some settling going on in the oil markets.

SEANA SMITH: Yeah, Dave. You mentioned the recent measures that they have taken just in order to try and stave off those additional losses. So today they announced that 8-for-1 reverse stock split. You also mentioned the fact that they have suspended issuing new shares.

Just in terms of why would the fund do this, do you have any insight there?

DAVE NADIG: Yeah. So there are a couple of things going on at once. One is there is a limit that no individual actor can own 25% of the deliverable positions in any commodity. That's a CFTC rule. Well, if they didn't change what they were investing in, they would have violated those limits.

So now they have to invest not just in June, but in July, August, and September contracts. Now, remember, the point of this fund is to track the front month futures contract, which is June. So obviously it's going to slip quite a bit from that stated objective.

But they really had no choice other than, perhaps, just shutting the entire fund down and liquidating it. The issue about closing for new creations, again, they didn't have much choice. They had so much inflow in such a short period of time that they had to file a registration statement to get new shares on the market.

Now, in the past when this has happened to other funds, it's taken anywhere from a couple of days to a couple of months before those registrations are approved. So at the moment, while it's closed for new money, I really think investors should be avoiding this ETF and look elsewhere if you're trying to get exposure to oil.

SEANA SMITH: Dave, if you want to look elsewhere, if you want to take the chance and bet on oil right now, speculate in oil, what's a less volatile strategy maybe out there for some of our investors who are looking for opportunities?

DAVE NADIG: Sure. So one is another fund from the US commodities funds called USL, which is the long-term oil fund. It actually just invests in the next 12 months of contracts on oil.

On that seat, that generally will make the contango-- that roll cost month after month will be much lower than if you're just in the front month, which is what this fund was trying to do a few weeks ago. So that's one strategy.

The one I like the best, actually, though, is the Invesco oil fund, which is DBO. And that actually uses math to pick the months it wants to own to mitigate that contango or, in some cases, actually profit from rolling into backwardation.

It wasn't so long ago that the oil market was in backwardation right now we're at the steepest contango I remember in a lifetime. So that DBO, I think, is probably a better way to play.

But it's worth pointing out that we're talking about an extraordinarily volatile asset class right now with really no good way to predict what's gonna happen, right? We're going to be in a supply glut for some time, and that's a really hard thing to get out of.

SEANA SMITH: All right. Dave Nadig of ETF Trends, director of research there. Thank you so much for breaking that down for us. We really appreciate it.

DAVE NADIG: Thanks for having me.

Our goal is to create a safe and engaging place for users to connect over interests and passions. In order to improve our community experience, we are temporarily suspending article commenting