This from Investment U:

You might think you’re properly invested in oil, but you could be wrong.

Despite reaching lows since 2004, the long-term outlook for oil is still up. Maybe not $147 a barrel like the old days (i.e. six months ago), but because of supply, demand, turmoil in the Middle East, and the fact that we will eventually resume worldwide economic growth, oil prices have only one way to go.

If you think you’ve positioned yourself according, or if you’re thinking about a new investment in oil… tread carefully. Here’s why:

I covered a situation last week call contango. It’s a feature of futures markets where you can buy oil cheap right now and lock in a contract to sell it in the future for a higher price. Normally, the difference between those prices is so close to the cost of storing the oil that it’s not a profitable trade.

But right now, we’re in a state of super-contango. Prices are way out of whack. And commodity investors are storing oil everywhere they can to earn the excess profits. (For a more detailed description, see contango.)

Contango is big news now. But some of the “traditional” oil investments that are being tossed around aren’t what they seem to be. In fact, if you skipped some very fine print, you could have set yourself up for a huge disappointment.

So let’s clear that up… and pad our pockets with a little extra in the process.

You’re Not Buying What You Think You’re Buying

When we broke the news on contango, we suggested looking at some oil storage providers, explorers and drillers. And that hasn’t changed. Looking around, there are a number of “oil investments” that look promising.

One would think the quickest way to invest in rising oil prices would be to simply buy shares of an oil-based ETF, like United States Oil (NYSE: USO). These oil ETFs are very popular – USO trades over 34 million shares per day.

But not so fast.

These funds don’t buy and sell oil for profit. They trade futures contracts on oil. And while there are a few ways to do that – some good, some bad – they may not be the best way to take advantage of contango. Let me explain.

USO buys a contract for oil for the very next month. Before it expires, they sell it off and buy one for the next month. In a contango situation the returns will indisputably be lower. (Conversely, during the opposite of contango, “backwardation,” the fund returns will be higher).

USO makes no secret of this. They print it in their risk disclosures that contango is not good for their fund.

And they are not alone. The iPath GSCI Crude Oil ETN (NYSE: OIL) and the Powershares DB Crude Oil ETN (NYSE:OLO) use the same methodologies. (Though OLO actively manages its roll forward strategy to reduce losses.)

But don’t give up on investing in oil.

Every Problem Has a Solution

In fact, the same manager that runs the USO fund runs another, custom designed to benefit from situations like this. It’s called the United States 12 Month Oil Fund (NYSE:USL). It uses a 12-month average of futures prices that will lessen the losses caused by a contango market.

Here’s the interesting thing. Oil markets usually exhibit a small amount of contango, it’s a natural result of price fluctuations. But its opposite, backwardation, is the rarity. So even if we were in a normal oil situation, wouldn’t the 12 Month Fund be better?

In fact, wouldn’t it make sense all the time? It would seem to be so.

Obviously, oil prices have been down… but you’d have fared significantly better investing in USL. Reading the fine print on an ETF isn’t the most entertaining way to spend your day, but it’s certainly worth a near 15% difference in performance.

If we were to enter a backwardation period, USO would then outperform. But since backwardation is so rare… you can expect USL will outperform consistently over the short and long term.

Source: The Wrong Way to Profit From Oil

This from Money Morning:

Many investors have given up on oil, fearing that a fall from grace precludes a rise in price from the ashes. But it’s worth noting that the oil markets are right now in a rare state of  ’super contango,’ which suggests that the markets expect far higher prices by next year.

Here’s what you need to know.

In case you’re not familiar with the term, ‘contango‘ denotes a normal and very specific condition associated with futures contracts in which the price of oil for distant delivery months from now exceeds the price of oil being traded right now on the spot market. Typically, the price difference is related to the cost of storing and insuring the oil itself.

An example might help. On Tuesday, oil traded at $38.81 a barrel on the New York Mercantile Exchange (NYMEX) spot market. So if we bought a barrel and put it into storage for the next five months, and assumed that would cost us 90 cents per barrel per month, under normal market conditions, we’d expect the June crude oil contracts to be priced roughly at $43.31 ($38.81+ the cost of storage for five months = $43.31).

However, according to the New York Mercantile Exchange, June crude oil contracts settled at $52.14 on Tuesday, which represents a state of ’super contango’ – and an excess potential profit of $8.83 per barrel ($52.14 – $43.31 = Excess Potential Profit of $8.83). But only for traders who can buy oil now and store it until then.

There are obviously wrinkles, of course, depending on where the oil is stored and how it is priced for delivery. But, in general, the spreads we’re seeing now are at, or near, their highest levels since April 2004, when the government started collecting Cushing data. Cushing is the delivery point for all NYMEX futures.

Super contango is a rare situation that causes most traders to drool – myself included – because it signals an arbitrage opportunity that’s literally too good to pass up if you’ve got the means to capitalize on it.

But, as usual, there are all sorts of unanticipated consequences – including a phenomenon we don’t see very often – hoarding at sea.

Tanker rates are skyrocketing as companies literally top off very large crude carriers with the 2 million gallons they’re designed to carry – and then park them offshore until prices rise. In the meantime, they’re also selling the June futures and locking in profits above and beyond what it costs them to buy and store their stash of this ‘black gold.’

Of course, with every tanker that’s stuffed to the gills as a storage container, there’s fewer of the big boats in circulation. And that’s caused benchmark supertanker rental rates to rise more than 56% since Jan. 1. But the perceived profit potential is so high right now, that even investment banks, which are hardly in the market for super tanker rentals under normal circumstances, are getting into the game.

According to recent reports by Bloomberg News, Phibro LLC, the commodities trading arm for Citigroup Inc. (C), has booked two supertankers to hoard crude oil supplies. Phibro recently stationed the 1-million-barrel carrier ‘Ice Transporter’ off the coast of Scotland and the ‘Ashna’ waits patiently on the U.S. Gulf Coast. Assuming they capture the entire $8.83 a barrel in excess profits we cited in our example, that’s a cool $8.8 million in the bank, just from the Ice Transporter cargo alone.

Based on my experience, traders tend to run in packs, so it’s highly likely that all the usual suspects are involved including most notably Morgan Stanley (MS), which owns half of tanker group operator Heidmar Inc. and Goldman Sachs Group Inc. (GS), which executes commodities trades and structures related deals through J. Aron & Co.

As many as 80 million barrels of crude are being stored at sea around the globe, according to Frontline Ltd. (FRO), the world’s largest owner of supertankers. That’s nearly enough to supply the entire world’s demand for a day.

As for what caused the super contango, the most common and widely accepted argument is that falling global demand has caused a current glut in supply that will be rectified by production cuts by the Organization of Petroleum Exporting Countries (OPEC) later this year. That’s certainly plausible and there is no shortage of data to support this contention.

‘That’s really what they’re betting on,’ said Opportunities in Options‘ Paul Forchione, a veteran trader with 30 years in the commodities markets. ‘A significantly higher price for the deferred contract month in excess of storage and insurance costs typically means traders expect demand to grow in the future.’

In his experience, Forchione said that ‘this situation is hardly the panacea that everybody thinks it is because it’s hard to put a limit on how far out of whack prices can get.’

However, there’s also another plausible explanation that seems entirely likely, based on conversations I’ve had with traders, officials and company officers in the oil business all around the world.

Basically, the super contango we’re seeing now could suggest that future pricing is as much about the fear of supply interruption as it is about present demand dropping. And that’s entirely logical given the constant state of warfare in the Middle East, threatened production in Africa, an unsteady South America, and China, which is structuring oil-supply deals with rogue nations as fast as it can.

I know from having addressed crowds of investors all over the world that this seems impossible, but at a time when China and India, for instance, are doing everything they can to stave off a global recession, it’s certainly not inconceivable. Moreover, if this is even remotely true, as a growing trail of evidence suggests, then the present super contango could also imply that traders believe oil will be increasingly hard to find, refine and transport in the months ahead. That, too, suggests higher prices to come

Now for the million-dollar question: What can investors do about it?

The most obvious choice for investors who think prices will indeed be higher come next June is to buy any of the half dozen oil-related ETFs. That includes The United States Oil Fund LP (NYSE:USO) or iPath S&P GSCI Crude Oil Total Return ETF (NYSE:OIL).

The problem, of course, is that the spreads companies are counting on for profits could drop rapidly between now and then. This would force companies currently hoarding oil to begin dumping it, thereby reinforcing even lower prices going forward. There is also the possibility that OPEC production cuts never happen, or are ineffective, which would also point to lower prices.

History suggests that far safer bets include mid-process transportation companies like TeeKay Corp. (NYSE:TK) or land-based alternatives like Kinder Morgan Energy Partners LP (NYSE:KMP). Both pay healthy dividends that can help stave off a personal recession no matter what happens with oil prices. That’s always important in rough markets.

For futures-savvy investors, there’s an even more direct bet. Data shows that ‘mean reversions’ are particularly powerful phenomena when it comes to commodities, so the fact that spreads have risen to all-time highs suggests that it’s only a matter of time before they reverse. One way to potentially capture that would be to buy March futures while selling June futures.

Risk management is paramount, regardless of which path investors choose. Super contango sounds to good to be true and we all know the old adage: If it sounds too good to be true …

Source: Contango Isn’t A Dance In Argentina: It is a Shot at Windfall Profits

Instead of working both metals over for a period of days, they did it in one fell swoop. Once the Comex opened in New York, there was an avalanche of selling. And once the 50-day moving averages were broken, tech funds sell stops were triggered and that was that. But they didn’t get gold below $900. The US$ was rising and the oil price was falling long before the bullion banks started selling on the NYMEX, so that’s no excuse.

Silver, of course, suffered the same fate…but the waterfall decline was prettier and steeper. I give them a 9.2/10 on that one. My criteria for any score over 9.5 is a drop of at least a dollar, and it has to be a nearly vertical line…and the straighter the better. My scoring criteria is based on a personally modified set of rules used by the Olympic high diving judges…which I keep in the fridge beside by bottles of blue and red pills.

Open interest for Friday’s trading were as follows. Gold o.i. fell 1,692 contracts and silver tacked on a surprising 2,421 contracts. I don’t know what to make of that. If it all gets reported today, the open interest numbers for yesterday should be quite impressive. Yesterday was not only options expiry for gold, it was the cut-off day for the Commitment of Traders report for this Friday. Will it all get reported then? Don’t bet on it.

Here is what James Turk over at goldmoney.com said this past Sunday in his private newsletter to his clients on what was about to happen in the precious metals market on the Tuesday opening…

OPTION EXPIRY: The following quote is from Letter No. 423 published on April 28th. “Readers will recall from years back how we could regularly count on the gold price falling into option expiry. Most options are written by the gold cartel, given their aim to be short and profit from the contango (the difference between the spot and future months). So at option expiry the gold cartel would drive the gold and silver price lower…so that as many calls as possible would expire out of the money, meaning that the gold cartel would earn the full premium on the options they had written. Therefore it was not chance that the precious metals collapsed again last week just as options were expiring, making sure thousands of calls expired out of the money.

“I’m revisiting this point to remind everyone that this week is expiry for the all-important June options, which have a large open interest. The open interest for Comex gold calls with strike prices from 900 to 930 is 13,905 contracts, representing 1.39 million ounces of gold. As a rule of thumb, I assume that the outstanding options in the over-the-counter market are 10-times greater than the quantity of options on the Comex.

“Right now (based on Friday’s close) the calls on the Comex have an aggregate market value of $21.2 million. If gold closes on expiry at $900 or less, that value completely disappears (as would of course the value of OTC options at those same strike prices also disappear), which is a powerful incentive for the writers of these options to force the gold price lower on expiry. So I expect to see a test of wills this week.

“Will the gold cartel once again be successful in driving gold lower during option expiry? Or will the market overpower the gold cartel? It should be an interesting battle. I don’t know who will win, but we should plan for a gold cartel victory. After all, the results from recent years suggest that they are batting around 0.750 in driving down the gold price at the end of the month, so it is likely they will do so again.”

There were dozens of stories over the weekend worth mentioning, but I can’t mention them all, so I won’t mention any. However, you may find this Bloomberg story about the Titanic of great interest…and amusement! The story is entitled “Titanic Model, With Deck Chairs, Attracts Million-Dollar Bids”. The link is here.

For today’s main offering, I present silver analyst Ted Butler’s latest weekly commentary on the silver market…including his take on yesterday’s slaughter on the Comex. His essay (which is a must read) is entitled “A Few Thoughts on Silver” and is linked here.

Our finances will never be brought into order until Congress is compelled to do so. Making our money redeemable in gold will create this compulsion. – Howard Buffett, father of Warren Buffet – May 4, 1948

What a day yesterday was! Horrific news in all directions! The Dow rolled over into negative territory and…at precisely 12:00 noon…”gentle hands” were there to make sure it stayed positive on the day. If you feeling like you’re living in the movie “Matrix”…you would be right about that. Score one for the PPT.

See you tomorrow.

Casey Research correspondent-at-large Ed Steer is a keen observer of the financial scene and a board member of GATA.org.

Source: And Then There’s This…Wednesday, May 28th, 2008