I wish I could conjure a better term for the move in the U.S. markets toward passive investing over the past 10 years than "ETF-ization", but that's all I have for now. It is very apparent today. For those who follow commodities, the United States Oil Fund (USO) ETF is a frequently-used benchmark. It is also a complete piece of garbage from an investment standpoint, but that's just a detail for the buffoons who mindlessly push ETFs.
The problem with ETFs is that they concentrate assets into a small number of positions. Any lack of liquidity in those positions can cause those ETFs to lose the ability to match inflows and outflows, thus altering the markets for the underlying securities. That doesn't happen often to SPDRs and QQQs and broad-based market index ETFs because of the liquidity of the securities that underpin both of these products: (AAPL) , (AMZN) , (MSFT) , (GOOGL) , etc.
That still leaves the vast majority of the universe of ETFs that are vulnerable to market dislocations, however. We saw this in February 2018 with the death of the short-volatility trade and the demise of the XIV ETF (VIX spelled backwards, how clever!) and we are seeing it today in USO.
USO's general partner, U.S. Commodity Funds LLC, dropped a bomb on the energy markets last night in an SEC filing. USCF noted that, in contrast to its stated objective of holding front-month crude futures contracts and rolling them into the next month's contract two weeks prior to expiration, the fund would now seek to hold 80% of its assets in the front-month contract with 20% split between the second-month and third-month contracts. It is simply too expensive for USO to roll over its contracts each month given the steep contango in the oil futures curve.
If you had $100 worth of oil futures and then you had to swing that into $120 worth of the next months' futures, you would end up holding fewer and fewer barrels of oil. That is exactly what is happening with USO, and thus the mismatch between USO's real-world assets and its stated objective to mirror the daily moves in crude oil futures.
Why is this important? Because, once again, USO's size has led to an enormous concentration of holdings. According to Bloomberg, as of yesterday USO held about 25% of the volume of front-month WTI crude oil contracts outstanding. That is a ridiculous amount of holding for one fund, and USO's "asset reallocation" sent front-month oil futures down to an incomprehensible low of $17.31/barrel in this morning's trading. That contract has now recovered to $18/barrel, but that level of crude pricing is very detrimental for the U.S. economy, given the massive increase in domestic crude production over the past seven years.
I smiled as I filled up my tank for the member price of $1.84/gallon at BJ's Wholesale Club yesterday, but I haven't been driving anywhere anyway, so that's not a huge benefit to my personal P&L. The obvious losers from low oil prices are Exxon Mobil (XOM) , Chevron (CVX) , and the state-dominated global giants like Aramco.
There are actually a few winners from low front-month oil prices and the steep contango in the oil futures curve itself. As I have noted in my last few RM columns, my firm is heavily weighted in companies that can store oil either in tankers ( (NAT) , (NNA) , (TNP) -F) or on land ( (NSS) ). As long as the oil futures curve remains steep I will continue to reinvest the double-digit yields those securities are puzzlingly paying into more of those same securities.
So, that's my micro view. On a macro view, there really are only two endgames. One, the oil futures curve gradually flattens and USO barely survives. Two, the Fed starts buying USO. President Trump has made the survival of the U.S. oil industry (and Texas' 38 electoral votes) one of his key priorities. If the Fed can buy bond ETFs like (LQD) and (HYG) (which has a strong energy cohort,) then why couldn't the Fed buy USO? In this crazy world, it is one of the least crazy ideas I can conceive of. I will stick with my high-yielders for now, but at some point, gaming a bailout of USO could be as lucrative as shorting USO has been for the past five years.