Friday, September 4, 2009

DXO Went the Way of The Dodo, Who is Next?


The popular DXO (Deustche Bank's double long oil ETN) is going the way of the Dodo: extinct. The official reason given and discussed elsewhere on the Internet is "Limitations imposed by the exchange on which Deutsche Bank manages the exposure of the Notes have resulted in a regulatory event as defined in the terms of the Notes".

However, the real reason is that the fund became too big. This reason is important because the same may happen to other ETFs.

DXO tracks the DB Optimum Yield – Crude Oil Index, which is all invested in the July 2010 contract. But DXO was an ETN, thus was not backed by contracts as ETF are (or should be). ETFs are supposed to be holding the real thing, not so ETNs.

However, because the funds was so large, in practice DB had to hedge pretty much 100% of their market risk (we hope), by buying futures contracts. Now remember DXO uses 2 to 1 leverage (wrongly referred to as 200%, but that is another story), which means, a lot more contracts! About $1B worth of contracts, which was simply way, way too much.

Who is next?

The clear suspects are USO and UNG. Both are too big and can actually influence physical market prices, yet another problem. UNG is a broken instrument. Prime target number 1.

The question is how to avoid losses with these ETFs (that is easy, don't buy them), or how to profit with their demise.

As for all other leveraged ETFs or ETNs, we can only hope they all went the way of the Dodo, but since they transfer hundreds of billions of dollars from mom & pop investors to the big sharks who issue them, that won't happen.

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