Contango Scares USO and DBO Investors

Saturday, October 10, 2009

Contango is the deepening discount of near month oil futures contracts against later months. This little monster is scaring investors off simple passive funds such as USO, DBO and OIL that helped drive the big oil rally in the last 6 years.

Passive index plays like USO and OIL found big profits during much of oil's rally to over 147 a barrel in July by selling front month futures contracts and buying cheaper ahead the curve contracts, something possible only in a market structure called backwardation.

Oil prices have collapsed to 35 dollars a barrel pushing front month futures contracts into a discount to later months. This is a market showing contango, which forces investors to pay out rather than profit when shifting cash from one month to the next. Now its extremely expensive to buy and hold oil. The rollovers will just kill you. The only explanation I have for this deep discount in fron month is the Government selling oil to stimulate the economy. But that would be too much, wouldn`t it?

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