RE: NEGATIVE ROLL OVER YIELD - RESEARCH22 Apr 2020 11:12
Fredr, you’re right this ETF does in fact track the performance of the bloomberg index well, but the bloomberg index “bakes in” the impact of negative roll yield so the index in itself isn’t trackIng the wti spot price 1:1.
It’s clearly a very unique set of circumstances at the moment given the “Super Contango” but the best way of understanding It for those that are new to this concept is:
If i invested 1000 USD in the index today at a spot price of 20 USD then I’m gaining exposure to 50 barrels. However the ETF isn’t actually going to take delivery of 50 barrels and keep them in a vault for me, so they take my money and generally buy next months futures contract. This way they actually have an cashflow stream to pay out any gains. The issue is that if the futures contract expiring were 10 USD (for ease of Maths) and the next months was 20 USD then the roll loses 10USD per barrel, so my 50 barrels exposure turns into 25 immediately whilst the spot price is still 20USD i.e. 50% loss. Clearly this is an extreme scenario and the expectation would be that the ETF fund manager would do as best as they could to mitigate this risk but you get the idea, all of a sudden my break even is 40USD per barrel.
Unfortunately it looks like this trend will continue (just look at the delta between the June contract and July contract at the minute) which is due to the market pricing in a relatively quick recovery in demand and seeing this as a somewhat short term storage issue driving down short term prices.
The best time to invest to reduce the impact of a super contango will be when the futures prices settle into a more normal pattern (i.e. slightly more expensive the further out you go to take account of the incremental storage costs over a longer hold period). Bizarrely this point may come at a higher price to the current spot price - if it’s lower than current spot prices that will most likely come at a point where the market realises that this isn’t going to be a quick demand recovery but a long deep recession. For me that’s the time to buy, but I don’t see that scenario until maybe August once the dust has settled and real economic data is out.
I’m not saying it’s impossible to make money at the minute in here, but its a gamble (needs big news rather than fundamentals) and people need to understand the risks they could be sleepwalking into..