Anthony Okolie talks with Andres Rincon, Director, ETF & Equity Derivatives Strategy about the nuts and bolts of crude oil ETFs and the risks and rewards in investing in commodity ETFs in volatile markets.
- Hello, and welcome to Money Talk's COVID-19 Daily Bulletin for Tuesday, May 5. I'm Anthony Okolie. In a few minutes, I'll be speaking with Andres Rincon, Director of ETF and Derivative Strategy at TB Securities about COVID-19's impact on the price of oil and oil ETFs. But first, a quick wrap of today's headlines.
The grim toll of COVID-19 walloped April home sales across Canada with the number of listings and sales taking the biggest hit in Vancouver, Calgary, and Toronto. The price of oil rallied for a fifth consecutive day on optimism the slow reopening of parts of the US and European economies, along with OPEC production cuts, will boost demand.
Meanwhile, a new forecast projects nearly 135,000 deaths due to COVID-19 in the US through the beginning of August, as states begin to reopen and ease restrictions. A grim milestone in the United Kingdom. The death toll from COVID-19 has climbed above 32,000, placing it above Italy and making the UK the worst hit in Europe.
Finally, Air Canada will soon require all guests to have their temperature read helping the airline to detect potential travelers with COVID-19 symptoms. And that is a wrap of today's headlines. Next, my conversation with Andres Rincon.
Andres, oil prices have plummeted in the last few weeks along with oil ETFs. So tell us what happened.
- So before we go into just crude oil ETFs, I want to get into also like, what commodity ETFs generally do. So, generally, these commodity ETFs try to provide exposure to a specific commodity, as the name implies obviously. So they'll give you exposure to gold, uranium, gas, crude oil specifically in this case.
They try to do it in two ways. They either go with physical exposure where they actually give you exposure to the actual brick of gold in this case. Or in the case of many of the crude oil ETFs, they give you exposure to derivatives.
The two most common derivatives used are swaps and also futures. As they mentioned earlier, when it comes to crude oil ETFs, the most common way that these ETFs give you exposure to crude oil is through futures. What they do is that they actually manage an active portfolio of futures. So let's call it a basket of futures.
So let's say if you, as an investor, wants exposure to the front end of the futures curve, then what they'll do is they'll buy a basket of short-end futures. And that's actually what a lot of these ETFs do. But bear in mind, these futures have an expiry. So as they near expiry, the fund will actually automatically roll into the other future, so that further out future.
So they systematically have to roll from one future to the other every month or so for the ETFs that track it on a monthly basis. But there's also ETFs that look at these products out to 12 months or so, so further out. So that's basically what it does. It acts actively gives you exposure to crude oil by managing a basket of futures specific in this case.
- What has happened to these products in recent weeks, given the volatility that we've seen in equity and commodity markets?
- Well, honestly, it's a combination of factors, as you can imagine. But it's really driven because of COVID-19. Obviously if you look at COVID-19, it's driven demand for crude oil much lower. Obviously you don't have people driving such as myself. I'm at home, obviously because I'm not driving a lot.
And you have a lot of shops also closed. So they need less oil. And auto industries are closed. They need less oil. So you have demand going lower. But supplies has actually remained relatively high. So what we've seen here is that crude oil and WTI specifically have seen a huge amount of supply. And there's really no storage.
So what that leads to-- and this is where it translates into financial products-- is that the short end of the curve in futures actually sees quite a bit of selling, because if you hold those futures that are supposed to give delivery of actual crude oil, and you don't have anywhere to store it, then what happens is you see panic selling in these short-term futures.
What's fascinating, though, is that despite all this volatility in crude oil ETFs and obviously the large declines, all of them obviously stopped trading. They halted completely. And many of them obviously resumed trading later on. But they've seen record inflows. If you look at the last two weeks in these product, they've seen record inflows. And it's quite fascinating to see that.
- So what has transpired since then, particularly with crude oil ETPs or ETFs?
- This, I would say four main things that have transpired in these funds. There's been quite a bit of a impact to these products. So number one, you've had the suspension of creates. Then you also have deleveraging of a lot of these products. You also have a fundamental change in the composition of the futures basket for these products. And you also have a lot of closures.
So I'll just speak to them really quickly. As I mentioned earlier, a lot of these products, in Canada and the US have seen their creations being suspended. As market makers, generally, we have the ability to create or redeem an ETF. And that has actually been fully halted. And we've seen this in the past. We've seen this in the past with commodity ETFs.
It can range from a couple of weeks to a couple of months. So it is quite significant there. Volatility ETFs also saw that back in February 2018, so just have a benchmark there. The other thing we've seen is deleveraging. A lot of the triple-leveraged and double-leveraged ETFs to crude oil have seen their numbers go down in terms of leverage.
The other one is closures that I mentioned earlier. Now, look, we've seen a couple of the biggest funds actually close. And at this point, we have a year to date about 80 closure, which is a pretty significant number, given that that industry is not that big.
And last but not least-- and what's more important is that these ETFs have changed the composition of their futures positions. They no longer really tracked it from front end of the futures curve. They've actually gone out to the second month and third month and fourth month.
And they've done it for a couple of reasons, mainly to protect the fund and to protect investors because of the volatility that's in the front end of the curve in crude oil futures. But the consequence of that is that if you buy these ETF now, many of them are not really giving you exposure to crude oil spot. They're giving you exposure to some other end of the crude oil futures curve. So that's quite significant.
- Given the recent plunge in oil prices, some investors might be thinking or tempted to jump in, thinking that the price of oil will rebound. Just a few seconds. What are some the risks to that type of thinking?
- It's very tempting. And we've gotten so many calls lately on this specific topic. It's extremely tempting. Obviously crude oil has gone much, much lower. But it's important to look into these ETFs. And, as we say, look, open the hood of these ETFs and understand them, because these ETFs right now, they're not working properly. If they're working properly, we really think that you should be looking at these right now.
- Just thank you for your time.
- Oh, Thank you.