Oil ETFs Set Up For Failure? This One Is…

| January 19, 2016 | 0 Comments

oilBe Careful With Oil ETFs Right Now!

Believe it or not, the price of crude oil is plummeting below $30 a barrel…

It wasn’t long ago that suggesting oil could trade at such ridiculously low prices would have got you laughed out of the room.  After all, the price of West Texas Intermediate (WTI) crude was trading over $100 a barrel as recently as July 2014.

No doubt about it, the past year and a half downturn in crude has been spectacular.

But with the commodity trading at a price that’s clearly unsustainable in the long run, many investors are plowing capital into oil ETFs in an attempt to catch the bottom.

The thesis is simple…

Buy into an ETF or ETN that tracks the price of crude oil and hold it until the market rebalances at a more sustainable price.

It’s buy low, sell high, in its purest form.

But as with many things in life, the devil is in the details…

Take the iPath GSCI S&P Crude Oil ETN $OIL for example.  The widely watched commodity ETN seems like a great alternative for investors to buy oil on the cheap.

Buy the crude tracking ETN at these low prices and you could make a windfall as the price of oil rebounds… right?

Not so fast…

Dig into the details of the note and you’ll find something surprising.  As of January 15th, 2016, $OIL has indicative note value of $4.12.  Compare that to last Friday’s market closing price of $5.61 and you’ll discover $OIL is trading at a 37% premium to net indicative value.

That’s bad news for holders of this overpriced fund.

How can $OIL be “overpriced”?

Let me explain.  All ETNs have a net indicative value that’s calculated each trading day.  In a nutshell, this net indicative value (or net asset value in the case of ETFs) suggests what price shares of the fund are actually worth.

But due to overwhelming demand from investors trying to pick a bottom in the crude market, $OIL is trading at a lofty premium to its net indicative value.

In other words, shares of the ETN are trading at an artificial premium to what the fund is actually worth!

Here’s the deal…

These ETN pricing anomalies usually end badly.

A nearly identical situation occurred in the iPath Natural Gas ETN $GAZ in early 2012.  Thanks to unwary investors trying to pick a bottom in natural gas, $GAZ traded at an enormous premium to net indicative value.

But the chickens eventually came home to roost…

The trading premium in $GAZ was erased by late 2012, sending shares of the ETN plummeting by over 50%.  Adding insult to injury, the price of natural gas actually rose by 100% during the same time frame.

While the current premium in $OIL isn’t as extreme as it was in $GAZ in 2012, the writing is on the wall.  Shares of this crude tracking ETN will likely underperform oil, or worse, in 2016.

Bottom line… 

The iPath GSCI S&P Crude Oil ETN $OIL is broken and should be avoided until the premium to net indicative value normalizes.

Remember, you should always check the sponsoring company’s website for a fund’s net indicative value (or net asset value) before investing.  If shares are trading at a premium of 5% or higher, look for better alternatives.

Until Next Time,

Justin Bennett

BIO:  Justin Bennett is the head commodity research analyst at Commoditytradingresearch.com.  With over a decade of real world trading experience, he finds ways for you to consistently profit from movements in commodities and the companies producing them.  Sign up for our free reports and commodity newsletter at https://commoditytradingresearch.com/free-sign-up.

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Category: Commodity ETFs

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.