ETF Edge - Drilling Down on Oil ETFs: Wild Swings in Commodities 5/8/23

Episode Date: May 8, 2023

CNBC’s Bob Pisani spoke with John Love, President & CEO of U.S. Commodity Funds, and Sal Gilbertie, President & CEO of Teucrium Trading. They drilled down on the big moves in both hard and soft commodities – taking a look at what the wild swings in crude, natural gas and wheat futures are telling us about the China reopening and broader global risks of a recession – and discussing how ETF investors can hope to play the commodities space right now. In the “Markets 102” portion, Bob continued the conversation with Sal Gilbertie from Teucrium Trading. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange traded funds, you're in the right place. Every week we're bringing you interviews and market analysis and breaking down what it all means for investors. I'm your host, Bob Pisani. Today on the show, we'll drill down the big moves in both hard and soft commodities with two of the best in the business.

What are the moves in crude, natural gas, and weak, futures telling us about the China reopening broader global risks of a recession as well. And how can ETF investors play the space right now? Here's my conversation with John Love, the president and CEO of U.S. commodity funds, along with Sal Gilberti. He's the president and CEO of Tukrium Trading. Okay, John, you run this largest oil, ETO, the U.S.O, the U.S. Oil Fund. It owns oil futures contracts, oil, you know, all over the place, 65 to 80, back to 70.

And that's just two months. OPEC's been cutting supply. There's worries about recessions. Try to make sense of this for us. What's going on? The two things you just mentioned are exactly what's going on. Oil has been bouncing around between those two factors for a while. It's been exacerbated over the last month or so. OPEC agreed to cut production, to protect the price just a month ago. And they've signaled they're pretty committed to that. On the other side, we definitely have recession fears. We definitely have just broad macroeconomic fears when Congress is fighting over the debt ceiling and the timeline on that moves up.

That definitely weighs on oil prices. And we can actually see this over the last few weeks as oil is moving more in conjunction with the equity markets than it normally does. So suggest that oil traders have the same concerns as equity market traders. And I think, you know, this bouncing a little back and forth may continue, but I definitely, you know, think we need to look at what OPEC has done. They've signaled, you know, as I said, they're definitely committed to this price. They need that oil revenue. On the other side of things, you know, if we talk about a recession, that's, you know, those recession fears are kind of priced in.

So I'm not sure there's a tremendous amount of downside beyond what we've seen. there's really not a good reason for it when supply may remain constrained for a while, and while demand is probably where it's forecast to be or slightly around the same level. Yeah, now you also run the largest natural gas ETF, the symbol there is UNG, and that's just tanked. That's very, oil is in a range. Natural gas is just tanked. It was, what, $7 back in December, then it went to $2, But it's stabilized. It's actually all for the lows. Have we hit a bottom? And what's driving the natural gas dynamic? Yeah, I hope we've hit a bottom. That quick sell-off that we've seen year to date actually started a little bit last year as well.

And the reason for it is oil had, I mean, natural gas had run up to $10 last summer, which is the highest level since 2008. And that was, you know, in the wake of the Russian invasion of Ukraine, which caused everyone to worry about natural gas supplies for Europe. And fundamentals even going, you know, preceding the invasion were strong. So we basically had a period coming out of COVID where things were looking, you know, pretty good for natural gas. And then you have this potential supply shock. And then that didn't materialize. And it didn't materialize because, one, the Europeans managed to, you know, get the natural gas they needed, stockpile more than they normally do.

And second, we had a mild winter. We had a mild winter in the U.S., mild winter in Europe, and that's going to contribute to a broad sell-off like we saw. You know, we all, we talked, Sal, like we're in favor of the commodity people here. But in fact, this was very good news, right? We were all terrified that Europe was going to freeze to death this winter, and it didn't happen. And even in the United States, it was a little warmer.

This was good news for the global economy, not good news if you're low on natural gas, but generally good news, right? It was great news, Bob. And the fact that there was no winter in Europe is what saved the world economically. I think we could have had an oil price shock, an energy price shock. It was there for a couple of weeks, and it went away, thankfully. We would have been in big trouble. I shared John's view that natural gas may have bottomed here. I think that demand in the U.S. for peaking units for summertime heat is going to pick up. And I think that your export demand for LNG, that'll still be there. And you've got

LNG plants coming back online that were off. So I think natural gas actually looks pretty stable right now. It's quite remarkable when you see what they're doing in Germany, the natural, the LNG facilities that they're building out there. Is this going to be a long-term thing? And John, jump in, but it seems like they're building out a whole new energy infrastructure over in Europe, independent of Russian natural gas. They are. They have to stay independent of Russian natural gas. They will for a very long time. I'm sure at some point out of our future, they'll go back to importing Russian natural gas. They're doing a workaround.

They're doing a good job. Everyone is hoping and praying for no winter again next year. That's really important. Yeah. John, the number of shares outstanding in U&G has skyrocketed this year. Can you explain why that's happening? I mean, it seems like traders are shorting natural gas using UNG, and then the market makers have to create more shares to accommodate that.

I mean, that's my interpretation, but what did you have to say? And if you want to add anything to what Sal has been saying, go ahead. Yeah, well, I'll start with that. I mean, just to add to what Sal said, you know, we're building out a tremendous amount of infrastructure here as well to, and we have been for several years, but it's continuing to grow. And one of the other factors that has led to lower prices is that producers normally when the price gets this low will shut in production, they'll start producing less. They haven't done that because they're looking out to the future. It's hard to get production back online or to

kind of catch up when you've shut in production. So they're looking to the future and that, you know, this huge export opportunity that's growing is really what they've got their eyes on. So I think production's probably kind of come in a bit this quarter, but not too much. And that's been another unusual factor. In terms of shares and flows into UNG, we've definitely seen, and other ETFs have seen that when prices get low in certain commodities, share growth follows. And I think there's a couple of reasons for that. Obviously, as you said, there's probably shorts and market makers creating so participants for so you know those shorts can be created but there's also people that are just looking at you know this just giant sell-off and if you look over time these big sell-offs

that happen there's sometimes they they hit a low and and that's people are thinking that's as low as it can go I will say that you know we have seen many times that it can definitely go lower but I think there's you know people out there looking at this and saying look a sell-off after this isn't, you know, after we've had a year where we've had natural gas at $10, is there some opportunity here? And I think people look at that as well. It is an odd feature of ETFs, create the lend, essentially. Yeah, the short sellers come in.

They want to short it, but you have to create more shares to accommodate the short sellers, essentially. That's right. Don't forget, as the price goes down, it takes more shares to fulfill your allocation. If you want to put $10 million into an ETF for an allocation, it's going to take more shares if it's lower price. You know, you've been in commodities for a long time, Sal. This guy's been around 40 years in the commodity business.

So Russia's selling all the oil it can to finance its budget. And, you know, there's plenty of willing buyers that are out there. But I want to talk to you about agricultural commodities. You have ETFs for wheat, for corn, sugar, soybean. This is the guy for agricultural commodities. Particularly for wheat from Ukraine. That was a big issue, right? What's the supply picture like right now, the wheat there?

Well, right now, it's fairly uncertain because we have a May 18th deadline for an agreement that Russia and Ukraine worked out through the UN and with Turkey's mediation. And if that deal isn't renewed, there'll be a lot of uncertainty about wheat exports. And, again, Russia and Ukraine combined, they export, they're the biggest exporters of wheat when you combine them in the world. Now, Russia exports four times more wheat than Ukraine. So they go right to the end in terms of bluffing, but it's in Russia's best interest to keep things running smoothly, keep that export window open.

Plus, they degrade through wartime efforts, Ukraine's exportable facilities anyway. So they can agree to a deal and bomb their ports, which is what they're doing. Yeah. And I want to, this is a good time to educate people about how these futures commodity ETFs work. You know, one distinguishing factor of all these two-grim agricultural products that you have is the structure of the underlying holding. So usually you get these commodities and they hold the front month. futures contract, but you know, you contract, these contract across multiple maturities, right?

That's right, they do. We extend out across the curve, what they say, out into the future, because generally you're either using this as a trading product, in which case you don't care where it holds, although you hope it holds the front, because you're in and out. But a lot of people allocate to grains. Grains spend a lot of time trading at their cost of production when there are times of surplus and balance. And does having it across multiple contracts reduce the roll cost? Yes, it does. I mean, that's a major problem. Yeah, we think it does because it depends on the shape of the curve, which does change. But we also, because you spread it out, we're not rolling the whole portfolio, say, 12 times a year 100%.

We're rolling the portfolio in corn with only five futures contract expiration. We're only holding three of them. We're rolling roughly a third five times a year. So it's a lot less in terms of rolling and roll costs. So you mentioned this U.N. Green Deal. That's expiring May 18? May 18. Okay.

Explain a lot. little bit about what this deal does and will it be renewed or not? This deal allows the free export grains come out of the Black Sea on ship. That's how they come out. Russia and Ukraine export, a vast amount of grain to the world. We need their grain. We need their wheat. We need the corn that comes out of the Ukraine.

Russia's not a big corn exporter. And when there's a war, people are worried about armaments going back and forth. So both sides want those ships inspected to make sure that there aren't arms smuggled that could support the war. So they broker through the UN and inspection deal, ships, come in, empty, ships that go out full of grain, that that's really what they're shipping. And so without that type of deal, then shipping of the world's number one grain exporter, number one wheat exporter is Russia.

Shipping will become uncertain because you'll be in a war zone, and people won't be in agreement that there'll be ships. There's a lot of uncertainty. Could those ships come under attack? So you see that underpinning of price uncertainty. But Russia's bluffed before. It does feel a little different this time. We don't know which way they're going to take the war.

So what's the supply situation? Is there an oversupply of grain? There's an oversupply of wheat in Russia right now. They need to move that grain. Really? So that means lower prices, right? That's correct. And wheat prices have been coming down.

But that weed's got to get out of the Black Sea. That's really important. And Russia's behind. They have almost 80% more stocks than above their five-year average. And they have a near-record crop coming out of the field in a couple of months. So they need someone to put it. It was afraid of, like, a massive grain shortage a year ago. and now we have a grain surplus.

Well, farmers are resilient. They plant even if there's a war. Unless your field's being bombed, you're a farmer, you're out there planting. Prices are high. You're motivated to produce. And that's what farmers, in fact, all commodity producers are doing. They're producing. Yeah, which is a good thing.

I mean, ultimately, we might talk like traders, but we're on the side of the consumers, right? I mean, global economy needs wheat. That's right. We don't want people paying through the nose for high wheat. At least I don't. I want to go back to oil, John. One of the strange features of the oil market is it's in backwardation right now. So you always got this knock against futures contracts like the USO.

It's in contango. That's the way your contracts should be traditionally, where the futures contracts are higher priced than the front month contract. The contracts that are farther out are higher priced. So when you roll into them, it costs money for these futures ETFs. But that's not the case here. Oil's in backwardation. The front month contracts are more expensive than the contracts that are farther out. So what is this telling us and explain how this might help or hurt a holder of an ETF like this?

Sure. Well, we could spend the entire segment talking about Contenco backwardation, but I'll try to simplify. So, you know, what it is telling us and to kind of sell, your question to sell about oversupply is when a market goes into backwardation, When the futures prices are cheaper than the physical price and they're getting cheaper as you go out the curve, we tend to think that suggests that either demand is greater than supply or market participants are worried about that happening. And if you are a, you're a refiner and you need crude oil in order to produce gasoline or other distillates, then, you know, you're concerned about having that crude oil when you need it. And if there's going to be a shortage in the future, you'd rather buy it now and not the future's contract.

contracts in the future. So what this tells us when we have backwardation is that, you know, there may be some concern that there's not going to be enough supply and people would rather would other own the commodity now. So what that tends to also tell us is that if supply is expected to be lower, there's a higher probability that prices are going to rise in the future. The reverse of that is contango. When you get contango when there's a glut of of a commodity. So prices tend to rise as you go out the futures curve. It's kind of interesting because contango has been more prevalent than not over the last decade or two, but it used to be considered in commodity markets, the backwardation was normal. So, you know, the futures can change, the curve can change, and I think it's important for investors to keep an eye on that. One last thing I'd say about, you know, in oil markets right now is that we actually have mild the moderate backwardation right now. I think it's between the front month and the contract that's a year out. It's about $4 right now. Last year, it average, $13. So I think what we're seeing is

some worries about supply, but not the same level of conviction you had in 2021 and 2022. Why would backwardation be normal for a contract? I mean, because the cost of storing, like, you're the ag guy, wheat corn, you're storing this stuff farther out. Isn't there a cost? Sure. When you have a prolonged shortage, you're going to have backwardation that be almost normalized. But I actually think we're going to flip. I think OPEC cutting is more that they're pessimistic about the economy. I think the futures curve is telling us that, that the oil is cheaper out in the future. People expect there to be more supply. We have these problems now in terms of commodities, but we're coming out of that. Producers have been producing.

I think commodity-related inflation is dead. I don't see producers are producing. The Fed is trying to kill the economy, or at least slow it down. I think, that in the end, we're going to see that we have enough commodities for now, for now. And you'll go back into a contangoed market. And who would have thought? We've got a major war that's disrupting the global grain supplies. And I said this before, we're in surplus. Tell us something, John, about how well these commodity ETFs track the price of oil and natural gas, particularly when you're accounting for the role.

This is always the knock, you know, people hate agricultural commodities because of the role. that happens. How well does it track price of oil and natural gas? So our products that, you know, track the front month, whatever it is, they're tracking. They do track very well. What people tend to look at is they look at a price at this point in time and a price at this point in time and they think that a futures investment or an ETF that invests in futures should show the same price movement. But what they're not accounting for is that you do have to roll. There is an expiration for each futures contract. So as you, as you, you know, you know, role, you're either adding, if you're in backwardation, you're adding a positive role yield,

and that's going to make you look better than the spot commodity price. And if you're in Contango, the opposite is true. You're going to have a negative yield. That's going to make it look worse. But all you've got to do is adjust for that role, and they track very tightly. Yeah. Now, here's a good way to distinguish this, because you have two oil ETFs, John. You have the USO, and that's weighted towards the front month contracts. But then you have an equal weighted, you USL is the equal weighted one. That's equal weighted over 12-month contracts, right? So people can have a choice here, right?

There's USO and USL. And actually, they track pretty closely together. But there is a choice here. And who would choose one over the other? Yeah, so right now they are tracking closely together, and that's you have very mild contango at the front of the curve is one reason. So there's not a big impact right now. But why would you choose one over the other? Well, if you're in a contango market, then just as Sal was talking about, because we own, in USL, will own those front 12-month contracts. It's only rolling a small part, 1-12th of his portfolio every month as opposed to the entire portfolio. And so that tends to mitigate the impact of contango. Now, the opposite is true if you're in backwardation. If you're in backwardation, you probably want to be closer to the front of the curve because you're earning that positive role yield. One other thing you can look at, we also have this.

same thing with UNG and UNL, when we have the 12-month natural gas strip, and the same thing is occurring. So when there's backwardation, you probably want to be closer to the front of the curve when there's contango. It helps to mitigate that contango drag. And we're putting this up right now. It's the same with natural gas, as you see here. UNG is just the front month. Is that right? UNG, just like USO? Yeah, it's front month and it rolls two weeks before expiration. For inspiration, right? And UNL is a 12-month, what you're looking at here, 12-month natural gas, equated over 12-month. Okay. And John, there was a story in the Wall Street Journal

that oil companies are all awash in money, which we all knew, but they did a story saying a lot of investors want the oil companies to return even more money in buybacks and different ends that they're doing already. Any thoughts on this and what's happening with oil stocks in the next oceans of cash are still out there for these oil companies. Yeah, yeah. Well, I mean, the oil producers after, you know, getting, you know, running up their debt last, in the last decade, they've restored fiscal discipline. They've been much more disciplined. They're much more reticent to overproduce. We do have an abundance of oil and natural gas in the country that we do have access to. But I think that, you know, the fact that

they've got fiscal discipline in place and that they are returning cash to shareholders is positive for those companies. I'm not sure it's the right. In the long term, we do need some development. But right now, you know, we really, with regulation and projects being stymied by the government, you know, it's hard to invest some of that capital. So I think sometimes the only option is returning it to shareholders. Well, it's obviously a lot of people want that. I'm personally a dividend. guy over a buyback guy, because buybacks are very nebulous about how they can affect share count. And not all buybacks reduce share count, because they keep adding on the other side. So I'm a dividend guy.

But even here, you've got to invest a lot of money. Yeah, and returning money to shareholders isn't going to return energy to the economy 10 years down the road. No, that's a problem. On the other hand, if your Chevron used to come, you know, that says, oh, the president wants us to go out and drill new wells, and then all of a sudden the price of oil collapses, and we're stuck with the cost of these giant, New Wells. We've seen this movie before, right? The energy companies know this, right? But that's the energy company's game. So if you make it hard for them to find oil and produce it and make it more expensive, you're just making it hard for them to give energy to the consumer.

And we need energy. We need more and more energy because the economy is growing. The green economy is slow to come. And whether the pace continues or not, it's not fast enough. So we really need more. Do you think Exxon is against the green economy? I mean, Exxon once said they're just an energy company and they sort of implied it didn't matter whether we're an oil gas or geothermal it didn't matter they want to live forever so i would imagine they're an energy company regardless of what the energy is yeah that makes john before we go just your thoughts on that is exxon an energy company and not a natural gas and oil and if they got into geothermal or solar or you know some other you know non-hydrocarbon business yeah absolutely you know any company that if if the economy moves towards clean energy and

they can make money on clean energy they're going to go there that route. If it's still going to be on fossil fuels, they still are going to stick with fossil fuels. So absolutely, they're an energy company. There is one thing I would add, Sal, you were talking about, you know, potentially flipping commodity markets into contango. I think there's one area, though, where we potentially have more room to grow, and that's industrial metals, copper, the battery metals. I agree, it's slow to gain, but there is potentially huge shortages coming in copper and things like that. I don't know if you might agree with that, but that's one thing I'd point out.

Well, you have a copper ETF, right? C-P-E-R? Is that it? Copper? That's it. Yeah. And so finish your thought on copper? Yeah, I mean, we just, copper is, you know, right now it's been a little under pressure. There's worries, again, about the recession. Copper. They call it Dr. Copper, because it tends to predict the direction of the economy. But I tell you, if

right now, there is just a shortage of copper that is being produced. And there is nothing like the Shale Revolution that follows on from this. So I don't know what, you know, in the near term, you know, it's hard to say, but I think in the in the next couple of years, copper and battery metals, we have a battery metals, ETF as well. We think that's probably a really strong play in this next, you know, next decade and even next couple of years. All right. Finally, I just want to mention something. Last week, ETF.com hosted its ninth annual awards night. I was there. My producer, Kirsten,

there. This is honoring the performance of top funds and contributions made by many heavy hitters in the ETF space. It was roughly 250 members of the ETF community in attendance. It was here in New York. Among the winners was Joanne Hill, who won this year's Lifetime Achievement Award. She's the chief advisor for research and strategy at CBO Vest, board governors for the CFA Institute and a lifetime pioneer, lifelong pioneer of the ETF industry. That was very important. CBO Best, again, with Joanne Hill. Other big winners included the JPMorgan Equity Premium Income ETOF. That's JEPI, that was the ETF of the year.

And the U.S. Treasury three-month bill ETF, that's T-Bill, who took on the best new ETF. Dimensional and Bond Blocks also went away with big wins, including ETF issuer of the year and new ETF issuer of the year, respectively. Now it's time to round out the conversation with some analysis and perspective to help you better understand. ETFs. This is the Market's 102 portion of the podcast. We'll be continuing the conversation with Sal Gilberti from Tukrium Trading. Thanks, Sal, for sticking around. I wanted to just ask you about some other agricultural commodities that we didn't get to in the regular show here. Sugar. You mentioned to me that you thought there was a big bull market this year. The futures are up 30% year to date. Is this a supply imbalance? And how do you play this?

I know you have a sugar ETF. Sure. And the sugar ETF's done. It's performed a along with sugar pretty well this year. But mainly it's a supply imbalance. We had some sugar problems in terms of production around the world. And then I think most key is that Brazil, the world's largest exporter of sugar, they can flip a switch and turn their sugar cane into either sugar or ethanol.

With the high price of crude oil and petroleum products, they flip that switch and they're producing more ethanol than sugar. So they have a lot less sugar, and that's a big deal. When Brazil has less sugar, the world has less sugar, hence you saw the supply imbalance and prices So that's an interesting point. They can adjust supply of sugar very easily by switching to ethanol production.

That's correct. And they're motivated by price. They don't care, which they turn the cane into. They just want to make the most money. Yeah, yeah. How about gold? I hear about a lot of central banks and private banks buying gold. Why are they buying gold?

I think in a world of uncertainty, you buy gold. That's what people do. It's been around for thousands of years. It's the stabilizer. A lot of people make it case, as you and I have spoken. about about crypto or Bitcoin, but, you know, gold is gold. It wins. It's sitting in central bank vaults. It's sitting in solid ETF vaults. Gold is the real commodity that money used to be based on. I mean, you used to back your currency by gold. And I think the fiat system,

when people begin to question it, you know, governments want to have gold sitting in their vaults to back their currency, even if it's not officially backed by gold. Yeah, we debate about whether Bitcoin is a, it, it's a, it's a, it's a, it's a, it's, you know, is really a currency, does it have the attributes of a currency? For example, most importantly, is it a store of value? And that is certainly debatable, but there's no doubt that gold has functioned as money throughout history. It has.

Even though you can't go down to the gas station and exchange an ounce of gold for a tank of gas, it is a store of value, that is for sure. I think it's proven itself on that level. And it always amuses me. We're in a new high for gold right now. I think gold goes higher. I think gold would be a lot higher if it weren't for crypto. The crypto space in terms of the crypto coins.

Do you think crypto draws people who would otherwise own gold? Well, I think, let me put it this way. I think it draws money that's looking for a store of value. It's not trading money. It's not people that think cryptos. So in the whole cryptocurrency space, what is there, about a trillion dollars, more than half of that is in Bitcoin. Some big chunk of that in Bitcoin anyway that's in cold storage.

That's just people saying, I want to park a certain amount of money somewhere and make sure it's worth something a long time of the future if something bad happens. All that money would have been in gold, however much that is. Yeah. And yet people say gold's an inflation hedge. I've never seen that to be true, though, necessarily. I would agree. I think gold is a turmoil hedge.

It's an uncertainty hedge. I'm not so sure, and I don't have the statistics, but I mean, I think gold more uncertain. Look, inflation breeds uncertainty, so people relate the two. But I think you've got political uncertainty. You've got fiat currency uncertainty. You've got all kinds of uncertainties that gold hedges against. And so that's why people use it. How about hard metals, base metals like copper?

We just had John Love on the president of the United States Commodity Fund. He has a copper ETF, C-P-E-R. How is the demand, supply demand situation there? It's going out of balance. Goldness Axis warned, I believe, that the world's going to run out of copper in terms of the supplies, when the supplies are needed. So I think there's an imbalance coming, not just for copper, but for all the base metals and for all, in fact, the green metals. And so while there's a debate going on over how the supply will match the demand, because eventually it will.

They'll dig new mines. They'll produce producers respond. But you've got some issues. And I love that fund, CPR. Our first foray out of agriculture is into a base metals fund that's a long short fund. Because, again, I don't know how the timing of the supply and the demand will match. but base metals and battery metals, they're going to be the talk of commodities for quite some time. How about rare metals, rare metals, a lithium, for example.

The rare earth metals, yeah. The concern here is that they're only produced in a few spaces in the world. Peru, China. China may restrict access to it. Are we actually in danger of not having access to rare earth metals? You may be from China, depending on how things get. I think in, like Chile, where they want to nationalize their lithium industry, That's a pretty scary thing. Nationalization doesn't work. You're more efficient when you have private producers in there. If the world's demand for lithium is rising and the major supplier of lithium, Chile, or one of the top two major suppliers, is nationalizing.

That's probably not a good long-term trend. I wouldn't think so. All right, Sal Gilberti is the CEO of Two Cream, which runs many agricultural ETFs. And has a long history in the commodity business. We really appreciate your insights. So thanks very much for joining us. And thank you, everyone, for listening to the ETF. podcast. Invesco

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