I Lost $17k Because I Forgot to Do My Research
Back in March, with the US stock market cratering, I first started getting interested in oil. Actually, ‘interested’ is hardly the word. Excited, more like. Because oil prices were beginning to tank (pun intended 😆) thanks to a confluence of possibly once-in-a-lifetime circumstances:
- Thanks to the pandemic, aircraft were grounded and people weren’t going to work globally, resulting in a sheer drop in demand never seen before
- But, on the other hand, Russia and Saudi Arabia were at exactly the same time having a spat around oil pricing, which meant that supply of oil was not restricted in response and continued pretty much unabated 🙄
As a result, oil prices fell below anything I had ever seen or even heard of before.
Together, these factors resulted in supply so far outstripping demand that there were literally no buyers for all the oil being produced, neither was there space to store it. Tales abound of tankers being rented not to transport oil to the willing arms of buyers around the world, but just to keep it somewhere — anywhere — while the world sorted itself out. And since even tanker capacity is finite, suppliers were reaching a point of having to pay people to take their oil.
For a brief, shining moment in our climate-destroying economy, oil was so little in demand that US oil prices actually turned negative!
… and the rest of the world wasn’t doing much better.
Enter Amit
As a keen investor watching the price of a highly-desired commodity approach zero, what was I to do? I was drawn like a moth to a flame, or maybe a moth to the fuel that would eventually go up in flames.
(In reading this again, I realise how poignant this statement really is given the events that were to unfold)
Act I: I smartly bought Exxon, an oil major, at a great price
My first act was to start buying up shares of Exxon, an oil major with a long history of dividends. As you’ll notice, the lowest dividend yield in the past 30+ years has been about 1.5% and it was hovering around a pretty attractive 5% already by 1 Jan 2020
But, here’s the kicker, at the time I started buying in, Exxon share prices had dropped in line with oil prices, and their potential dividend yield was hovering close to a massive 8%. I placed trades on Mar 10 (8% yield) and Mar 23 (11% yield 💵), taking advantage of a continuing drop in prices to average my price down. Unfortunately, I didn’t have the guts to go all-in on the 23rd, which, in hindsight, turned out to be pretty much the bottom.
Sorry, am I boring you vultures with tales of my successes? I know, I know — you’re here to witness a train crash so let’s keep it moving.
Act II: I decided to go a step further, and buy oil directly to cash in on an expected oil rebound
Having nailed the stock buy, I now turned my sights on the commodity itself. As a long-term investor, buying units of an oil fund seemed a no-brainer. In a year or two — or four — a Covid vaccine or a solution of some sort would be found. Economies would burst open and consumers would come roaring out in their SUVs and planes and cruise ships and oil prices would bounce back with a vengeance. I was pretty sure I’d net a minimum of 3x my investment when that happened, if not more.
Laptop in hand, and dollar signs in my eyes, I set about looking for an oil fund that I could buy into. And, voila, I discovered USO, a 14-year-old fund that tracks the prices of US oil mostly by buying oil futures.
As expected, USO had dropped in tandem with the rest of the market and was trading at around $58, a 40% discount to where it had been just 3 months earlier. I jumped in with both feet.
(Note: USO had a reverse split late in April. For consistency with the prices you’d see online now, I am quoting the split-adjusted prices)
As oil continued to drop, USO followed suit. I bided my time, tracking it closely for weeks — 58… 50… 45… 40… 35…
Now all this might have fazed some of you but I’m made of sterner stuff. I was convinced about the future of oil and willing to average my cost even lower. I’d have bought oil even at $0 if there was a way to do it!
Finally, I thought I had it — what was as close to the bottom as it would ever get. On Apr 22, over a month after my first purchase, USO reached $20.
Without a second thought — and not consulting with my financially-savvy wife — I piled in, more than doubling what I already held.
Act III: And then things unraveled
The deed done, I went to brag to S, my wife, about how we’d probably be able to retire earlier than planned. She agreed in principle — we both actually were pretty bullish on oil — but she’d read some disturbing news and was worried about this free-falling ETF that we had buried ourselves deep in.
“Amit,” she said, in a worried tone. “This USO. Are you sure it’s an oil fund? I read that it invests in futures. I thought it actually buys the oil. Do we want to be invested in futures?”
“Don’t worry about it,” I replied, flicking on the TV. “How does it matter what it is? It’s in oil. It’ll go up eventually.”
A few minutes passed.
“Amit, it says here that their investing method forces them to sell any expiring futures contracts at month end and buy into the next month’s futures. Apparently this puts them at risk of something called contango. What’s that?”
“Dunno.”
“And the price seems to be falling further,” she was beginning to sound really worried.
“Amit, call X. She invests in commodities. She’ll know.”
Much against my wishes, and with a lot of grumbling, I called X. Really, S could be quite a pain sometimes.
“USO?” X asked. “No, no. Definitely not. Don’t buy. It’s going to tank.”
“That’s ok,” I explained. It was obvious she didn’t understand where I’m coming from. “I’m a long term investor. I’m happy to hold it till it rebounds. I don’t need the money immediately.”
“Dude, you don’t understand. They’re in deep trouble. The fund might even close down. I hope you didn’t buy any of it. If you did, just sell it and get out immediately.”
“But why?” I asked, determined not to be talked out of this golden opportunity.
“Have you heard of contango?” she asked.
“Err.. yes,” I replied. Of course I had. S had just told me.
“Well, USO is currently facing the risk of super contango.”
“Umm, ok… yeah, got it,” I replied, half-imagining a barrel in a cape and underpants soaring through the sky.
“Do you know what that means?”
“Uhh, somewhat…” I said, not knowing somewhat at all. “But do go on.”
“Well, in short, USO is at risk of losing all their money. They invest in oil futures. Which means, if the contract expires while they are still holding it, they have to take delivery of the actual oil. Millions of barrels each month. Which of course they can’t. So they have to keep selling their contracts just before they expire and buy into next month’s futures contract. Thanks to super contango, next month’s contracts are way higher priced than their current contracts, so, till oil prices normalise, they are in a position of always selling at a loss. If this doesn’t get fixed soon, they will be trading their way to zero.”
“It gets worse,” she went on. “Tons of mis-informed investors 😧 are piling into USO under the mistaken impression that they are buying into oil prices, which is driving up their funds under management and forcing them to buy and then robotically sell even more of these futures contracts at a loss. In fact, some of the oil price decline in the US can be traced to just the actions of this single fund!”
I hung up, walked back to my laptop and quietly sold everything we owned of USO.
Transaction completed, I added up the losses. S was standing right behind me.
-$17,000
I dared not even look at her. For a long moment, she was still. Then she walked away.
Lesson Learned
I’ve made some dumb investing moves in my life, but none as bad as this one. Losing money is part of the investing journey but with USO I just got it entirely wrong.
- I didn’t do my research: At the most basic level, I should have realised that USO does not invest in oil directly. And this wasn’t some hidden piece of info — this is clearly stated in their prospectus and, frankly, there were articles being written about exactly this issue even as I plonked down all that money into the second tranche
- I didn’t ask for help: I always knew X was an expert on commodities, and in fact so are several of our other friends. I should have just checked with any of them upfront
- Worst of all, I didn’t take my partner’s opinion: We are in this journey together and both of us need to be on board when it comes to large sums of money. I needed to have taken S into confidence at least on the second round
Epilogue
Following the disasters of April that burned not just me but tons of other retail investors, USO was forced to update their investing strategy to cover longer time periods than just a month. They also executed a 1 to 8 reverse split to bolster the price of their units, which is never a sign of a healthy stock or fund. And they faced a class-action lawsuit for misleading investors and, in fact, issuing more shares in the ETF even as their prospects rapidly worsened.
As I was researching this article, I noticed this new warning posted on the USO prospectus page.
Hope someone reads it.
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Note: I am not a licensed financial advisor. Please use any advice, tips, tools and other material as guidelines only and seek help from a certified financial planner before taking any action
