Pros and Cons of Investing in an Oil ETF
I am considering investing in DBO. They seem to have worked out contango and backwardation better than OIL. Not sure we have seen the bottom, but it seems to me that despite demand implosion, the supply side of the equation will be manipulated in the near term (US leaning on Saudis to decrease production, for example). I am not a day trader, so this would be a long term play (couple of years or longer). I have no stake at this time and I am genuinely open to educated opinions on the topic.
Many of these ETFs in commodities are not what you would hope they would be and will not necessarily do what you would hope that they do. The fine print will tell you. You may be better off buying a beaten down but solid petroleum company and getting the benefits of both capital gains and dividends.
If you want oil exposure, better to invest in an ETF that passively tracks an index of oil companies than to gamble with oil futures or to pick your own stocks. Rick Ferri has a good section on why not to invest in commodity futures in his great book All About Asset Allocation, and it was regretable that while I read the book in 2011 before I came across ChrisMartenson.com, in 2013 I seemed to forget all about it when I invested in a commodity futures ETF. I learnt my lesson the hard way. Now gearing up to invest in index funds tracking all developed countries, no more stock picking for me. I figure that the market probably knows way more than I do about the prospects for oil companies, and to the extent that they are any good going forward, they’ve probably been already priced into those stocks’ values.
Here’s a quote from the book:
“Mutual funds and ETFs that invest in futures must roll contracts from one month to the next to avoid thousands of gallons of oil showing up at the company’s doorstep on the futures’ expiration date. The roll yield can be positive or negative, depending on the relationship of next month’s futures prices to near-term futures prices. In a simplistic sense, if the commodity is in backwardation, the second month contract is less expensive than the first month contract, and buyers can earn a profit. If the commodity is in contango, the second month contract is more expensive than the first month contract, and buyers lose out. For many years, energy futures buyers made money from an oil market stuck in backwardations. According to data from Barclays Capital, oil was in a state of backwardation about 57 percent of the time between 1983 and 2007. However, the gains earned during those times became losses in 2006 when the market went into contango. This hurt ETF investors. The United States Oil Fund (symbol: USO) was the first crude oil ETF on the U.S. market. USO began trading on April 10, 2006, at $68.25, a price roughly equal to that of a barrel of oil at the time. The fund closed one year later at $52.01, representing a decline of 23.8 percent. During that same period, however, the U.S. benchmark price of crude oil fell only a modest 6.5 percent. Much of the extra loss in USO was a loss resulting from the negative roll yield from an oil futures market that moved into contango.”
Ferri, Richard. All About Asset Allocation, Second Edition . McGraw-Hill Education. Kindle Edition.
Thank you very much for the input. I will consider that.