Be Aware of Contango Trap in Commodity ETF

Exchange-Traded Fund (ETF) has become very popular in recent years. However, it appears to me that many people misunderstand the functions and abilities of ETFs

Today, I am going to just share a simple example of Contango Trap in Commodity ETF which deteriorate the return of your investment. After the 2008 financial market crash, a lot of people jump into the U.S. Oil Fund (USO), hoping a big gain from the underlying crude oil market. However, the ETF never delivers the return which many people expected to be.

You can easily tell the significant difference from the chart below.

USO-Spot — Source: http://www.dailymarkets.com

This is because when the future contracts that commodity funds own are about to expire, fund managers have to sell them and buy new ones; however, during the time, they have to pay a much higher price to buy back the same contract they just sold, resulting in a loss. This phenomenon is called Contango.

And who is the biggest winner in these trades, when your portfolio is bleeding? They are always the banks and financial institutions which you trust the most. I won’t go to details about how they make the money, but you should always seek professional advice before going into any such investments.

About the Author

Ivan Guan is the author of the popular book "FIRE Your Retirement". He is an independent financial adviser with more than a decade of knowledge and experience in providing financial advisory services to both individuals and businesses. He specializes in investment planning and portfolio management for early retirement. His blog provides practical financial tips, strategies and resources to help people achieve financial freedom. Follow his Telegram Channel to join the FIRE community.
The views and opinions expressed in this article are those of the author. This does not reflect the official position of any agency, organization, employer or company. Refer to full disclaimers here.

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