Gemfinder Q1 2020 – FREE oil for everyone!

And when I thought I had seen it all:

The US oil price has now bounced back into positive territory overnight, with a barrel costing a whole dollar.

The Guardian, 21st of April 2020

(not a sentence one ever expected to write)

This is the definition of supply and demand in a market which swings anywhere between “free” and “fully manipulated”. You see, oil is a funny commodity. On one hand, we have the usual demand from airlines, factories, cars etc. This has taken a big hit because nothing moves in the COVID-land.

On the other hand, we have suppliers, countries such as Russia, Saudi Arabia, the US, Iran etc. These guys normally have an agreement between each other to limit their output so that prices stay high. You probably have heard the OPEC cartel which consists of 14 countries that come into these production-cut agreements.

Then you have Russia and the US who are not part of OPEC but still want high prices. It’s a win-win situation. Until it’s not. Russia saw the falling demand while the Americans increased their synthetic oil production (aka shale) and said: “No, we’re not cutting ours”. Which caused panic as the Saudis increased theirs.

Global production increased at the same time that demand falls. As if that’s not enough, storage is running out. So traders and producers are running out of storage space and want someone to take the oil off their hands. Who knows until when.

oil tanker
No smoking please. Thanks. This is less of a problem for oil extracted in the water as huge tankers can float around as storage units. But WTI, the one’s crashing is ground oil.

Looks like the market is closer to free than manipulated right now. And that ladies and gentleman has caused the oil price to be negative. So the producers are actually paying people to take the oil that’s delivered in May.

Who will pay me to fill up my car?

Oil prices have hit negative but no, no one will pay you to fill up your tank. Ever.

The oil is negative in the futures market, which is a type of market where you pay for something that will be delivered in the future. So people who have paid for oil delivery in May have nowhere to store it. Desperate traders who hold the May futures contract want to pay someone to take the oil and avoid taking physical delivery. They will pay less money than what it will cost them to store it!

But unless you can take physical delivery of the barrels in Cushing, Oklahoma this info is nothing more than catchy headlines. The active price of the (WTI) oil for June is around $17 at the time of writing (24th April). still low but there’s a $50 difference between -$37 and $17. Have a look yourself on Yahoo Finance.

But as Big Ern likes to joke around, if you want to make a quick buck, all you need is a place to safely store the barrels until next month.

Buy oil, it’ll surely go up after COVID?

If you want to invest in oil, you must first understand how the sausage is made.

I believe we will see higher oil prices when things start moving. But there’s a problem. Retail investors like us cannot easily benefit from the price increase. There are huge ETFs like USO that track the oil price but they use rolling forward futures and suffer from the Contango effect. That’s when future prices are higher than the spot price.

Contango

These oil ETFs track the price of oil but in extreme movements like this, the 1-month future prices are much much lower than the 2-month and 1-year prices. This means that the ETF has to sell this month’s oil at low prices and buy next month’s/year’s futures at higher prices. Continuously doing that means to sell low and buy high.

So higher oil prices won’t necessarily mean higher ETF prices. How to solve this? I don’t know. What you’re probably looking for is an ETF that holds actual barrels. Not sure if ETCs like CRUD:LN that have a different structure suffer to this. If dear reader you know better, please enlighten us.

On another note, I guess most of us are looking forward to the economy opening up again. Not sure how we’ll do this, there is no playbook. I guess gradually while monitoring that COVID cases don’t spike again while waiting for a cure.

The times we live in…

But fear not for humanity. I’m not willing to bet against us, just yet. We’ll find a way as we always do.

This Gemfinder lists plenty of links to read on investing, financial independence and some podcasts too.

In case you missed it, I recently wrote the following articles:

Investing

Once stocks fall 20%, long-term returns start to improve with every leg lower:

by Michael Batnick

Howard Marks discusses the similarities between gambling and investing. As an ex-pro gambler myself, I know that the most important takeaway is this: In probabilistic areas (investing, gambling) luck plays a role. Therefore, you should not judge the quality of your decisions based on the result. It could be that you made the right decision at the time, but ended up being unlucky. This does not necessarily mean that your decision was wrong. You need to improve the process by running it many times which should reduce the impact of luck on the outcome!
I’ve read Thinking in Bets which describes exactly that, taken from Poker.
You Bet – Howard Marks (20-min read)

Capitalism on the way up, socialism on the way down. Professor Galloway has a point saying that big corps want to share the pain with everyone when they go bankrupt but don’t share the profits on the way up.
Capitalists of Cronyists? Prof Galloway (5-min read)

Vanguard thinks the Coronavirus crash will cause a sharp GDP contraction and then an upswing. What some people call a V-shape.
A sharp contraction then an upswing – Vanguard (4-min read)

A list of ideas, in no particular order and from different fields, that help explain how the world works. Some of them are SO important and always relevant. Like the Pareto principle: The majority of outcomes are driven by a minority of events. Explains how 80% of the traffic in this blog comes from 20% of the post.
100 Little Ideas – Collaborative fund (13-min read)

Value investing is not dead yet. I’m a big fan of Rob Arnott’s work.
Reports of values death may be greatly exaggerated – Research Affiliates (60-min read)

It’s funny that passive investors do all the buying during such times, as I’ve mentioned before. The selling is done by institutions combined with a lack of buying from corporations. I think this is great news for us, passive investors as a community. We have been accused of causing the “index bubble” – if this makes any sense whatsoever. We will see what passive investors do when the market goes down. Here, we’ve just seen – they’re hanging in there.
Who fueled the fastest bear market ever? Schwab (5-min read)

Meb Faber is one of my favourite hedge fund managers. Buffet commentary, expectations management and history. Great gem.
How long can you handle underperforming? Meb Faber (6-min read)

Although gold alone is an asset not worth investing in, it may have its place in a portfolio for diversification purposes, especially in gloomy times. My own opinion is that we’ll see gold shine more if the QE and UBI efforts of central governments make fiat currency be worth less. More money chasing the same goods.
My thoughts on perma bears and gold – Value stock geek (19-min read)

Stunning data/analysis from Damoradan on equity risk premium, real estate and bonds.
Price of risk – Damodaran (9-min read)

Personal Finance

This mind-blowing article explains very well why Money is a subjective thing. When I think of the money I think safety, freedom, holidays and endless possibilities. In that order. Freedom as leisure, freedom in work. I’m also donating to this guy through Patreon because I think his work is of very high quality.
Money – More to that (30-min read)

Unsurprisingly, the average UK FI blogger has a 105-age stocks allocation and owns multiple assets. I’d say most of us are still in the accumulation phase.
The asset allocation of UK FI bloggers – Med FI (4-min read)

Some people here max out their SIPPs, ISAs, capital gains taxes and then look at VCTs. Here’s an article by Finumus saying that VCTs are structured with fees so high which makes the whole thing not quite attractive.
Don’t invest in VCTs – Finumus (5-min read)

Podcasts

James Clear, the author of Atomic Habits (great, great book) talks to the Choose FI guys (Podcast) about setting goals and building systems. This guy is very reasonable and I can see why his book is now a best seller. He also has one of the best twitter feeds 😉

City living: Is it healthy? Can it affect our mental health? Are there ways to offset the stresses of living in a big city? This is a new podcast from Thriva, the blood test service [get £10 off if you use my affiliate link]. It’s called “How does *blank* affects your health”.
Thriva Episode 02: City living

Dan’s firm does a lot of quantitative research to spot what works in the markets. In this episode he talks on the Invest Like The Best podcast about the assets they focus on.
Investing through a crisis – Dan Rasmussen

Damoradan, the NYU professor is the voice of reason both in calm and turbulent times. I quite like his data-driven approach. He even gives stock index estimates from a fundamentalist’s / fair value point of view.
Aswath Damodaran talks to Prof Galloway [Jump to the 18th minute]

And an article for fun:

If you want to know how pawn shops work, this is your article! The Hustle breaks down the economics of Pawn Shops in such an interesting way (also recently watched “Uncut Gems” and found it brilliant! If you can bear the unstable camera shootings).
The unpredictable economics of pawn shops – The Hustle (6-min read)

You can read the previous Gemfinder articles here.

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10 thoughts on “Gemfinder Q1 2020 – FREE oil for everyone!”

  1. There are a couple of journalists that tried to buy some oil a while back- it didn’t work out very well for them (TLDR: it’s nearly impossible to actually buy). The storage is really difficult too, it gives out highly toxic gases- which can literally kill anybody nearby. And yet, this is what we use in our cars (refined of course)- still pretty crazy. Not for long though I guess…

    Reply
    • Journalists? 🙂 I can imagine, it must be really dangerous to store oil. I guess even if wanted to take physical delivery, I’d probably outsource the whole ownership/insurance thing to professionals. Similar to how people buy physical gold with Bullionvault.

      Reply
  2. Makes for a good read Michael.

    When WTI dropped below 0, the first thing I did (after eating my porridge) was open a short on Brent.

    I closed at ~$20 and reversed my position. Went long WTI at the same time. Both are currently up and I intend to hold until at least $45.

    If the spot price becomes too wide between the two, I might short Brent again. But… generally speaking – I’ve had my ‘short’ term fun, now I sit and wait. It might be a few months, could take a year. I don’t have a crystal ball, just patience and a reasoned opinion.

    I’ve been ‘trading’ oil like this for years, using Wisdomtree ETFs (CRUD and BRNT). Never had any issues.

    Over the past 11 years I’ve made 17% a year with oil, I love the black stuff!

    Reply
      • I just use another ETF! Basic, but does the job. 😀

        I’m sure I could save a few % a year using a dedicated trading platform, but an ETF through my brokers (one being HL) is okay.

        Oil prices are generally rational and follow a cadence, recent events have put this way out of the acceptable range. Sure, the economy can hold this down for many months but the reality is, supply will slow and we will see some elasticity up. We could of course see a trench down before that, but I’m confident within a reasonable period a buy at ~$20-25 is a sound position for a mid-term view.

        I think it comes down to the same old thing, if you can sleep easy on your decisions – keep making them. I sleep like a baby.

        Reply
        • I thought the main issue with owning oil is that you can’t simply buy and hold as you suggest during these times because of contango. To give you an example, CRUD ETF was around $5.00 when WTI was $32. As we speak WTI is down to $24 and CRUD’s price is $2.65. See the problem? Oil is 25% down so CRUD’s price should be $3.75 in theory. A 30% difference!

          Sure you can buy these 1-month future products but it has to be very short-term so I’d be interested to hear more about how you do it.

          Reply
          • Contango is indeed a problem for impatient retailer investors, if the price at spot vs futures contract is out then each month the ETF will cover and lose x%. But it works both ways i.e. backwardation when price returns and outpaces the futures price.

            I’ve held ETFs for months at a time without issue, letting them settle the ‘paperwork’ and take their fee. Yes, this does mean next month because of contango I could lose 30-50%, but months down the line that could be a positive 30-50%.

            During this period, I will short against myself if I feel contango is an issue, give myself temporary cover. I typically only short for … short periods. Days, weeks, never months because then I wouldn’t sleep easy!

            The biggest risk is the ETF goes bang. Not impossible in the current climate… but then any business can go bang too.

            All I know is that ‘dollar averaging’ has worked for me through the last recession and I’d wager it will again, oil is part of that process for me. 🙂

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Hi! I’m Michael and I love writing about different ways to earn, save and invest our money. Coffee addict :)

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