Announcement

**mikedev10** · February 27, 2009, 03:07 AM

Re: CFTC waking up?

does this mean i should be making a mad dash out of USO ?

**cobben** · February 27, 2009, 06:22 AM

Re: CFTC waking up?

No, that's probably what they want you to do - probably better to buy it today if it crashes for no good reason.

**GRG55** · February 27, 2009, 10:36 AM

Re: CFTC waking up?

Originally posted by $#* View Post

Finally CFTC has discovered that something may be wrong with the ETF/ETN toy manipulating the oil prices.

http://www.bloomberg.com/apps/news?p...7qr_I&refer=us

They've even discovered the mystery of the contango effect produced by the synthetic derivatives .... I wonder if they just got smarter or someone is reading iTulip

Of maybe it's a "What Goldman wants , Goldman gets effect" and probably Goldman wants now to hike the oil price ...;)

But it still doesn't explain why we saw the same price spike behaviour in commodities as diverse as uranium, wheat, zinc, nickel, etc. Synthetic derivative ETN/ETF toys in every case? Or is this just one of several factors acting in concert?

**Supercilious** · February 27, 2009, 12:36 PM

Re: CFTC waking up?

Originally posted by GRG55 View Post

Synthetic derivative ETN/ETF toys in every case? Or is this just one of several factors acting in concert?

IMHO it was a case of synthetic derivative ETF/ETN in every case. Even cocoa, lard, greasy wool and rizuki beans :eek: trading was infected. Even the iron ore, which is not traded on the regulated future markets but had a whole unregulated OTC market.

What we see in the futures regulated markets is just the tip of the iceberg. The bulk of the money playing the commodities game (the submerged part of the iceberg) is on OTC markets, which are completely unregulated.

At the oil bubble thread I posted that WSJ article about the iron ore if you remember.

**GRG55** · February 27, 2009, 06:03 PM

Re: CFTC waking up?

Originally posted by $#* View Post

Finally CFTC has discovered that something may be wrong with the ETF/ETN toy manipulating the oil prices.

http://www.bloomberg.com/apps/news?p...7qr_I&refer=us

They've even discovered the mystery of the contango effect produced by the synthetic derivatives .... I wonder if they just got smarter or someone is reading iTulip

Of maybe it's a "What Goldman wants , Goldman gets effect" and probably Goldman wants now to hike the oil price ...;)

United States Oil Fund says not aware of CFTC probe
Fri Feb 27, 2009 12:08pm EST

NEW YORK, Feb 27 (Reuters) - United States Oil Fund LP USO.P on Friday said it was unaware of an investigation the U.S. Commodity Futures Trading Commission said it had launched against the exchange-traded fund.

The CFTC said on Thursday it was investigating the fund -- which has swelled in size in recent months to hold about 20 percent of the front month crude contracts on the New York Mercantile Exchange -- concerning a large NYMEX trade made on Feb. 6.

USO sold more than 85,000 oil futures for March delivery on Feb. 6 -- accounting for nearly a quarter of the market's open interest -- and purchased nearly 78,000 contracts for April delivery, according to its website.

"United States Oil Fund, LP, while it does have ongoing discussions with its regulators, is not aware that it is a subject of any CFTC investigation regarding the trading on Feb. 6th, 2009," Chief Investment Officer John Hyland said in a statement.

"To the extent that there is any such investigation, United States Oil Fund, LP and its affiliates will fully cooperate. United States Oil Fund, LP puts a high value on compliance with applicable laws and regulations since an orderly and transparent market instills confidence in our investors."

A spokesman for the CFTC was not immediately available for comment.

The ETF is a passive investment vehicle traded on stock exchanges that allows non-oil trade participants exposure to oil futures movements.

The fund sells front month crude futures and buys second month crude at a predetermined point each month, called the "roll" period.

Some futures traders said the size of the USO's position being rolled over a short period -- just one day -- had depressed the value of the front-month and boosted the second month contract. USO on Feb. 18 said it had extended the monthly roll period to four days.

USO currently holds about 59,500 front-month April NYMEX oil futures contracts CLc1, according to the fund's website, out of total open interest of around 294,500 for April.

The fund also holds 4,000 financially settled NYMEX April oil contracts and over 31,000 April U.S. oil contracts on the Intercontinental Exchange. The market value of all USO's oil positions topped $4.3 billion as of Feb. 26.

**Supercilious** · February 27, 2009, 09:28 PM

Re: CFTC waking up?

Yeah, I bet they are completely surprised, stunned and can't understand what is this all about. Anyway it seems the ETF/ETN synthetic cat is out of the bag.

One big question still begs my mind. Who may have been the leader of the gang of players who were getting their fat monthly pay checks by front- running the monthly roll-over of USO and other long only ETF's ? Gee ... I can't think of any names .....:rolleyes:

http://ftalphaville.ft.com/blog/2009...elled-pyramid/

A self-propelled pyramid?

Posted by Izabella Kaminska on Feb 25 11:37. Stephen Schork of the Schork report jumps on the United States Oil Fund issue on Wednesday. He too is blaming the size of the ETF for current distortions in front-month Nymex WTI contracts.
He refers specifically to the March/April roll when spreads moved from $3.26 to $8.18 and expired at $1.09. Quite a volatile move. He explains (our emphasis):
As we outlined at the time, this volatility was largely attributable to �the roll� by long-only commodity index funds, particularly the United States Oil Fund ETF (USO). Open interest in the March contract was 363,757 on February 05th. Per the fund�s website, the USO rolled 85,057 contracts the next day. In other words, the USO held sway over the market, i.e. these funds (USO, S&P GSCI et al) are artificially skewing the front of the NYMEX curve; putting downward pressure as they sell a massive percentage of open interest in the spot over the course of a few sessions.
The USO has since announced it will roll over the course of four sessions instead of one; the April/May roll will take place in between March 06th and 09th. The fund is holding length of 61,940 NYMEX futures, 4,000 NYMEX WTI financials and 30,583 ICE futures, 96,523 contracts in total with a market capitalization (as of last night�s close) of $3.86 billion.
All this length will have to get rolled in a couple of week�s time. What�s to prevent front running the roll? Nothing, that�s what. Over the last three sessions the April/May contango has moved from $2.14 (-5.1%) to $2.80 (- 6.6%).
Which leads him to make one very brave assertion, a comparison to a pyramid scheme. To clarify - Schork is not saying the USO is an outright pyramid scheme itself. He is asserting the nature of the market, the established participants and the fund�s structure is such that it inadvertently encourages a passive self-propelled pyramidization to take shape. One fuelling the other so to speak. As he explains:
So how is this like a pyramid scheme? A pyramid scheme is funded by a constant flow of dollars into the venture by new investors. The second investor knowingly and willingly pays the first investor on the assumption he will get paid by the third investor� and so on. It�s similar to a Ponzi/Madoff scheme, with the key difference, investors don�t know (or don�t want to know as long as those alleged returns keep rolling in) they are being scammed.

The USO is being funded by a proliferation of new retail investors looking to diversify into �alternative investments� (which as far as we have been able to ascertain, alternative investment is a euphemism for Las Vegas style bets on commodities by retail investors tired of watching their 401Ks drop). More importantly, these investors are obviously out of their league, i.e. taking buy-and-hold positions in a contango which raises their cost basis every month they roll into the higher priced deferred contract.

We assume they are buying the USO because they are bullish. But in a peculiar way, their actions could be helping to prevent the market from rallying. These new investors are not funding a pyramid per se, but they are helping to fund storage. That is to say, with global demand in the doldrums, the contango will persist. And, as long as it lasts, traders will continue to front-run the rolls, which in turn will exacerbate the contango, which will then incentivize storage builds further, which will then ultimately weigh on oil prices.
The important thing to remember is that all of the above conditions create a very unfavourable investment climate for retail investors holding USO. Oil market participants win precisely because they can play the contango trade effectively and predictably. Retail investors just lose and will continue to do so until either the contango disappears or the oil price shoots up beyond the rate of their losses. Yet many analysts agree the oil price is unlikley to ascend much higher while the contango is in place, and as Schork highlights, the contango is unlikely to disappear while the market can continue to benefit from its structure.
The question is what happens when, and if , the whole thing does eventually go pop?
This is something the CFTC may be worried about too, note their latest proposed rule changes on commodity pool operators, which are calling for more detailed reporting of among others the sums invested �different type of markets� by commodity pools in connection to their trading strategy. In the USO�s case that would include investments in Treasuries and cash (due to the practice of buying at margin at Nymex), with cash equivalents sitting largely in Goldman Sachs Financial Square Funds, according to the fund�s last financial statement. Specifically the CFTC states it proposes:
2. Combining Gains and Losses on Regulated Futures Transactions With Gains and Losses on Non-CFTC Regulated Transactions in the Statement of Operations Regulation 4.22(e) provides that a commodity pool�s Statement of Operations must itemize the pool�s total realized net gain or loss from commodity interest trading and the change in unrealized net gain or loss in commodity interest positions during the pool�s fiscal year. Regulation 4.22(e) does not provide explicitly for separate disclosure on the Statement of Operations of realized and unrealized gains and losses on non-commodity interest trading activities. In 1995, Commission staff issued an interpretation of the requirements for itemization of realized and unrealized gains or losses in the commodity pool�s Statement of Operations.\17\ The interpretation noted that trading is often done by commodity pools using strategies that combine financial instruments from different types of markets, and, to reflect meaningfully the results of such trading strategies, permits the separate reporting of realized and unrealized gains and losses that combines the results of commodity interest trading and non- commodity interest trading that are part of the same trading strategy. The interpretation further noted that reporting realized and unrealized gains and/or losses for commodity interest transactions separately from other financial instruments that are part of the pool�s trading strategy may be misleading to pool participants as the separate reporting may distort the real results of the pool�s trading strategies.
In order to formally establish staff�s interpretation, the Commission is proposing to amend Regulation 4.22(e) to state that realized and unrealized gains and losses on regulated commodities transactions presented in the Statement of Operations of a commodity pool may be combined with realized or unrealized gains and losses, respectively, from non-commodity interest trading, provided that the gains and losses to be combined are part of a related trading strategy. Furthermore, gains or losses from foreign currency translations and conversions also may be included with the related trading strategy, or reported separately.\18\
The above information is important because USO depends on its Treasuries income to mitigate losses from the contango structure in the market. The fund itself explains this in its last statement of operations filed in November 2008, covering the 9-months up until September 2008:
The foregoing fees and expenses resulted in a net yield on an annualized basis of approximately 1.10% and affected USOF�s ability to track its benchmark. If short-term interest rates rise above the current levels, the level of deviation created by the yield would increase.
Conversely, if short-term interest rates were to decline, the amount of error created by the yield would decrease. If short-term yields drop to a level lower than the combined expenses of the management fee and the brokerage commissions, then the tracking error would become a negative number and would tend to cause the daily returns of the NAV to underperform the daily returns of the Benchmark Oil Futures Contract.
We are now in a low interest rate environment and a deep contango structure. A reminder, on the contango factor, the fund says this:
If the futures market is in contango, the investor would be buying a next month contract for a higher price than the current near month contract. Hypothetically, and assuming no other changes to either prevailing crude oil prices or the price relationship between the spot price, the near month contract and the next month contract (and ignoring the impact of commission costs and the interest earned on cash), the value of the next month contract would fall as it approaches expiration and becomes the new near month contract. In this example, it would mean that the value of the $50 investment would tend to rise slower than the spot price of crude oil, or fall faster. As a result, it would be possible in this hypothetical example for the spot price of crude oil to have risen to $60 after some period of time, while the value of the investment in the futures contract will have risen to only $55, assuming contango is large enough or enough time has elapsed. Similarly, the spot price of crude oil could have fallen to $45 while the value of an investment in the futures contract could have fallen to $40. Over time, if contango remained constant, the difference would continue to increase.
Accordingly:
There is a risk that USOF will not earn trading gains sufficient to compensate for the fees and expenses that it must pay and as such USOF may not earn any profit.
All of which, of course, affects the NAV of the units. This is irrespective of the market price of those units, which can be trading higher because of high secondary market demand. The fund�s methodology bets on the fact that arbitrage windows are quickly closed by selling and redeeming units to authorised purchasers at NAV prices (as dictated by the general partner). This sees market prices revert to the NAV.
A reminder, in the situation where secondary market demand is high � potentially threatening the units� linkage to WTI � the General Partner has the ability to �issue� units to authorised purchasers for exactly the aim of reverting it back to the NAV. Cash received from issue sales is then invested in securities that achieve the fund�s aim (that being tracking WTI). The fund aims not to be leveraged at all, rather to invest in enough WTI contracts at a margin to reflect the overall �cash� position of the fund - eg. it can�t take the full assets under management and punt them at margin on WTI. In the fund�s words: �USOF seeks to invest its assets such that it holds Oil Futures Contracts and Other Oil Interests in an amount equal to the total net assets of the portfolio�.
It can issue as many units on demand as it wants until its registered allotment has been depleted. Even then, there is nothing stopping the fund from registering further securities, which it did as recently as January 22nd according to SEC filings, no less than 306,100,000 units at that. To compare, the current number of outstanding units in the market place is 155,900,000.
Interestingly, the fund�s current cash holdings at $4,286,909,207 also significantly outstrip current total net assets at $3,810,356,060.62, which suggest it is not fulfilling its above aim very successfully. It could also mean the fund is fresh from selling brand new fresh units it hasn�t as yet had the chance to reinvest back into the WTI market.
Remember from the prospectus:
�because USOF will incur certain expenses in connection with its investment activities, and will hold most of its assets in more liquid short-term securities for margin and other liquidity purposes and for redemptions that may be necessary on an ongoing basis, the General Partner will not be able to fully invest USOF�s assets in Oil Futures Contracts or Other Oil Interests and there cannot be perfect correlation between changes in USOF�s NAV and the changes in the price of the Benchmark Oil Futures Contract.
And this:
USOF pays brokerage charges of approximately 0.16% based on futures commission merchant fees of $3.50 per buy or sell, management fees of 0.45% of NAV on its average net assets, and over-the-counter spreads and extraordinary expenses (i.e., expenses not in the ordinary course of business, including the indemnification of any person against liabilities and obligations to the extent permitted by law and required under the LP Agreement and under agreements entered into by the General Partner on USOF�s behalf and the bringing and defending of actions at law or in equity and otherwise engaging in the conduct of litigation and the incurring of legal expenses and the settlement of claims and litigation) that can not be quantified. These fees and expenses must be paid in all cases regardless of whether USOF�s activities are profitable. Accordingly, USOF must earn trading gains sufficient to compensate for these fees and expenses before it can earn any profit.
On a side note, the USO also outlines in its last statement that while it hasn�t yet, it can invest in �other oil interests� ranging from across the derivative energy commodity spectrum, and not excluding off-exchange OTC contracts too. These sorts of investments carry obvious risks as far as maintaining the ETF�s tracking of WTI, among them liquidity, counterparty risk and uncorrelated performance. The fund�s recent venture into the Nymex WTI financial contract, however, as highlighted by Olivier Jakob, perhaps highlights some degree of experimentation in its investment tastes of late. As a result investment in �other oil interests� cannot be ruled out in the future by investors.
The question to be asking therefore is not what will happen when the whole thing goes pop, rather what will prompt it to go pop. The answer potentially is any slowdown in investment flows, which are currently propping up the fund�s NAV and allowing it to service its expenses (including the cost of its rollover). The larger it gets though, the more inefficient it gets in the current market.
Related links:
The United States Oil Fund mystery - FT Alphaville
USO prospectus - USO
Return of the reverse con - FT Alphaville

**GRG55** · February 27, 2009, 11:50 PM

Re: CFTC waking up?

Originally posted by $#* View Post

Yeah, I bet they are completely surprised, stunned and can't understand what is this all about. Anyway it seems the ETF/ETN synthetic cat is out of the bag.

One big question still begs my mind. Who may have been the leader of the gang of players who were getting their fat monthly pay checks by front- running the monthly roll-over of USO and other long only ETF's ? Gee ... I can't think of any names .....:rolleyes:

http://ftalphaville.ft.com/blog/2009...elled-pyramid/

I gather you see a conspiracy?

What if it's just another market "inefficiency" created by a bunch of illiterate retail investors who have no idea what they are actually buying, being exploited by the same people that always expoit these dislocations?

**Rajiv** · February 28, 2009, 12:41 AM

Re: CFTC waking up?

Originally posted by GRG55 View Post

What if it's just another market "inefficiency" created by a bunch of illiterate retail investors who have no idea what they are actually buying, being exploited by the same people that always exploit these dislocations?

That is probably indeed the case, along with a failure of regulation, a lack of understanding of the systems used, and how they can be misused. Lack of prosecution of people who misuse the system -- e.g. the "Failure to Deliver" issue raised by Patrick Byrne in Deep Capture.

The rot can spread and create havoc system wide.

**jtabeb** · February 28, 2009, 01:07 AM

Re: CFTC waking up?

Originally posted by $#* View Post

Yeah, I bet they are completely surprised, stunned and can't understand what is this all about. Anyway it seems the ETF/ETN synthetic cat is out of the bag.

One big question still begs my mind. Who may have been the leader of the gang of players who were getting their fat monthly pay checks by front- running the monthly roll-over of USO and other long only ETF's ? Gee ... I can't think of any names .....:rolleyes:

so the US can MAKE OIL CHEAP with this huh? Pretty cool trick, bet it's pissing a lot of oil producers off. Man I'm really getting sick of this string-puppet show.

So what's next, I take it interest rates continue to go down, therefore the oil price tracks better, voilla, even more effective oil price reductions.

Symbols, I what's the big picture, what's going to happen. I mean, I think I figured out the flaw in my originional thesis. That flaw was that the powers that be ACTUALLY wanted to FIX a bankrupt system. I have since remedied my self of that illusion, so what comes forth next from the neoliberal economic machine? I thought I knew. But right now my head is still spinning so I have no idea. Your previous call on oil was really good and EJ and crew seem to be throwing in the towel on any sort of near or intermediate term recovery and Lukester sold all of his silver and went long the USD and soon maybe the broad stock market as well, so where does it go from here.

(notice it have correct my misuse of "where do WE go from here", where does the game lead the string pullers to next, that is my real question)

Thanks

(And Yes I get that vomit feeling everyday now, every single day)

V/R

JT

**Supercilious** · February 28, 2009, 02:21 AM

Re: CFTC waking up?