However, investments in these types of derivative instruments bring terms such as contango and backwardation into the equation.
In the case of ETFs like the United States Oil Fund ( USO) here is how contango has played out.
The ETF will be losing value every month because of contango, not because of the performance of the underlying commodity.
Prior to the speculative fervor of the last decade, contango was the exception, and would occur only in unusual circumstances.
So, to explain contango, lets find some common ground where we can all relate: buying jugs of water at the supermarket.
According to Bloomberg, Brent was in contango on Tuesday, which means longer-term contracts trade at a premium over short-term contracts.
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But, as Lynch points out, oil futures don't usually trade in contango.
So, contango was the exception, that is, until Wall Street got involved.
For example, if a drought occurred and the coming harvest was expected to be much lower, the futures prices may be in contango, i.e.
With crude oil futures markets typically in contango, the funds tend to lose ground to the spot price every time they roll-forward expiring contracts.
The PowerShares DB Oil ETF attempts to minimize the negative effects of contango by buying the contract month with the highest effective roll yield when necessary.
Oil futures have been in contango since mid-May, in contrast to their usual state, known as backwardation, where prices continually drop from the current spot price.
What about the contango effect (when the price of a barrel of oil for delivery in six months is higher than an identical barrel bought on the spot market today)?
The United States Oil and iPath products, the only ones around since last summer, are down from then because of the contango and because crude prices today are lower than in mid-2006.
Contango involves a scenario where future prices for a given commodity are higher than spot prices whereas backwardation involves a scenario where future prices for a given commodity are lower than spot prices.
The current contango in oil markets (meaning: future prices are above spot prices) has allowed Plains to make a low-risk profit buying oil for its own account, selling futures and letting the purchased oil sit around.
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