Gosh. On some days it feels exactly like 2008. It’s not, of course, but everything about the current environment feels oh, so late cycle. Until this week, crude oil was the commodity sector’s saving grace. Indeed, as the largest component of the S&P GSCI Index, strength in crude has masked weakness elsewhere in the commodities world. Below is a comparison of several commodity-related exchange-traded products where you will see the USO ETN, which holds underlying contracts for WTI Crude oil, as the top performing.
While normally I’d advocate simply being long energy stocks versus the commodity itself, given futures investing math, there are select periods where it is more beneficial to be long the commodity versus the equity. 2018 thus far has certainly been one of those periods. The below Bloomberg screenshot compares YTD returns for the USO ETN versus S&P 500 energy sectors.
But why is this occurring? One reason is due to the inverted (backwardation) state of the futures curve. Notice below the inverted spread that has persisted throughout 2018, essentially making long crude oil a positive carry trade.
Front-month futures contracts are set to dip below the price of contracts for a year from now
Also, notice how that spread has narrowed dramatically in recent weeks, which puts us closer to a negative carry situation. Coupled with the sharp downward move in crude oil price technicals, it looks for now that it will be much more difficult for long only passive owners of oil and general commodity indices to earn asymmetric returns in the near future.
Oil technicals have reversed sharply in recent weeks – Source: Stockcharts
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