Friday, March 31, 2017

EVCM fund's investment thesis for USO

Emerging Value Capital Management, LLC

Full Year 2016 Letter to Investors 

Short USO (Oil ETF)
United States Oil Fund (Ticker: USO) is an ETF that is supposed to track the price of a barrel of oil (WTI - west Texas intermediate oil). In theory, it is an interesting financial product that allows investors to easily invest in (or bet against) the future price of oil. It is mostly owned by retail investors that view it as a proxy for directly owning barrels of oil.
Like many Wall-Street “products”, USO is a wolf in sheep’s clothing. USO does not own any oil directly. Instead, it uses futures contracts to gain exposure to the price of oil. Because these futures contracts are usually in contango (front months cheaper than later months), USO suffers from “roll decay” which makes it lose value over time. Every month, USO needs to sell the front month futures contracts that it owns and replace them with futures contracts that are one month further out, and therefore more expensive. As the month goes by, the newly purchased futures contracts become the front month futures contracts and the process repeats again, every month, forever. This can be summarized as “buy high, sell low, repeat every month forever”. Simply put, USO does not accurately track the price of oil and is likely to cause large losses over time to its investors.
We have been short USO on and off in the past and it served us well, especially towards the end of 2014 and again in 2015 as the price of oil fell sharply. We closed out most of the position at a nice profit at the end of 2015. With WTI Oil prices up about 45% in 2016, we think it is shocking that USO was up only about 7%, lagging by almost 38%. WTI Oil now trades around $54 per barrel, so we think USO is once again an attractive short and we recently we re-established a large short position. Over the years, shorting USO has proven to be the gift that keeps on giving and we fully expect this to continue in the future. 

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