But if you want to profit from that rise, USO isn't the way to do it.
This is a big deal. According to the Wall Street Journal, investors poured $3.46 billion in new money into the U.S. Oil Fund in December and January. That makes my hair stand on end, because those investors have gotten crushed. And if things stay the way they are today, they're going to continue to get crushed.
The reason is contango. The oil market is in violent contango right now. All else being equal, any strategy that focuses on buying the front-month futures contract and rolling it forward is going to lose money. A lot of money.
This is simple mathematics, and it pains me that people are missing the story.
Here are the current prices for oil contracts with expirations in the next six months. Notice how every contract is more expensive than the one that preceded it. USO follows a simple strategy of buying the current contract and then rolling into the next contract before the current one expires.
- March 2009 $40.42
- April 2009 $46.22
- May 2009 $48.88
- June 2009 $50.45
- July 2009 $51.28
- August 2009 $52.70
Until last Friday, USO owned the March 2009 contract. Specifically, it owned 84,378 March contracts, entitling it to 84.4 million barrels of oil. Friday it sold all those contracts and bought the April contract instead; but, because the April contract cost $6/barrel more than the March contract, it couldn't afford as many contracts. In fact, if you exclude new inflows into the fund, it could only buy 73,444 April contracts.
Whammo presto, the holders of USO lost 13.4% of their exposure to crude oil. If the spot price stays near $40/barrel, the value of those April contracts will decay back to $40/barrel over the next month and investors will lose their shirts. If the price of oil jumps 15% in the next month—before USO rolls again into the May contract—investors will only break even.
This contango effect killed oil investors in January, according to Standard and Poor's, which runs the most important commodity index in the world.
Contango cost you 12% in January. And it's worse now.
What's so horrible about watching people plow their money into an investment that they don't understand is that there are so many nice, viable alternatives out there.
The same company that offers USO offers a great little fund called the U.S. 12-Month Oil Fund (USL). Rather than simply holding the near-month futures contract, USL holds equal positions in each of the next 12 months' worth of futures contracts. Spreading out its bets like that helps minimize contango, which tends to be worse in the near-month contract, and gives you more direct exposure to the spot price of crude.
Not surprisingly, over the past three months, USL has outperformed USO by 13%.