3x Oil Disappears, and Smokestack Sector Rotation

Listed trading for the two most popular leveraged oil plays will end Thursday, December 8, 2016. It will mark the largest closure of any ETF or ETN in U.S. history. Exchange-traded product closures are usually a run-of-the-mill iwae-120716operation where a sponsor closes a fund, delists it, liquidates the assets, and then returns money to shareholders, all within a few days. It’s happened without a hitch more than 600 times for U.S. investors in ETFs and ETNs from iShares, PowerShares, SPDRs, and others. However, this simple shareholder-friendly process seems to get turned on end when Credit Suisse (CS) is the product issuer.

Credit Suisse has taken the unusual step of delisting the VelocityShares 3x Long Crude Oil ETN (UWTI) and VelocityShares 3x Inverse Crude Oil ETN (DWTI) without liquidating them. Much of the initial media coverage of the Credit Suisse press release either missed or glossed over the biggest part of the story: Credit Suisse would not be automatically redeeming the ETNs and returning the money to shareholders. Sure, Credit Suisse will still honor owner-initiated redemptions, assuming you have 25,000 shares or exact multiples thereof. However, that mechanism is intended for Authorized Participants (“APs”) and market makers. I doubt that many retail owners hold shares in those exact quantities.

At the time of the announcement, UWTI held $1.57 billion (81,607,583 units at $19.22) in assets, and DWTI held $227 million (2,990,404 units at $75.83). This easily makes UWTI the largest announced closure ever, far surpassing the $600 million in assets held by PowerShares DB Crude Oil Double Long ETN (former ticker DXO) back in 2009, and the $508 million in the CS X-Links Cushing MLP Infrastructure ETN (former ticker MLPN) just two weeks ago.

The latest information on the VelocityShares website shows that $749 million still sits in UWTI and $220 million in DWTI (as of 12/6/16). With nearly $1 billion still residing in these two instruments, there is either going to be a massive rush for the exit on Thursday, or a large number of traders (dare I say investors?) are going to learn what it means to try to sell an unlisted, over-the-counter, closed-end, unsecured debt obligation. Credit Suisse also said they were suspending the creation of any new shares. Therefore, in addition to being delisted, these products (soon to be formerly known as UWTI and DWTI) will be broken products, subject to premiums and discounts along with a complete lack of liquidity.

If you haven’t disposed of your shares yet, then I would suggest you do so before the deadline. These are trading vehicles—not investments. You do not want to “trade” 300% leveraged commodity vehicles in the illiquid over-the-counter market. Professional arbitrageurs will be waiting to take advantage of you.

Many owners of UWTI and DWTI have asked me what other funds provide 300% exposure to crude-oil futures. The answer is “none.” However, there are alternatives. The ProShares Ultra Bloomberg Crude Oil ETF (UCO) and ProShares UltraShort Bloomberg Crude Oil ETF (SCO) pair provide 200% daily exposure. Granted, you will have to allocate 50% additional equity to get the same notional exposure, but the ProShares offerings are ETFs instead of ETNs, and 2x products have much less leverage-induced decay than 3x leveraged products.

However, if you really want the juice of having 3x, 4x, 5x, or more exposure to crude-oil futures, then I strongly suggest you open a futures account and trade oil contracts directly. Not only can you avoid the next Credit Suisse fiasco, you can control the exact amount of leverage you want, and you do not have to contend with the daily reset of that leverage. However, futures trading is not for the faint of heart, but then neither is 3x ETN trading, and you will have to roll your own contracts (or else take delivery).

Delisting without liquidation isn’t new. Credit Suisse delisted three ETNs in 2009 and didn’t redeem (liquidate) them until four years later. Deutsche Bank (DB) delisted five Merrill Lynch Elements ETNs on November 17, 2008. It’s been more than eight years, and owners of Elements Australian Dollar ETN (former ticker ADE), Elements British Pound ETN (former ticker EGB), Elements Canadian Dollar ETN (former ticker CUD), Elements Euro ETN (former ticker ERE), and Elements Swiss Franc ETN (former ticker SZE) still have not received their money back.

Two years ago, Janus Capital Group acquired VelocityShares, and with it, the VelocityShares brand and trademarks. Both Janus and VelocityShares have been surprisingly quiet on this whole issue. Surprising because they are allowing Credit Suisse to tarnish their brand. However, Credit Suisse is the issuer of the notes, which apparently puts them in the driver’s seat.

The unanswered question is “why” Credit Suisse is doing this, especially since UWTI and DWTI were obviously successful products. Presumably, it is an exercise in balance sheet management in an effort to keep the bank on the right side of European regulators and their stress tests. We saw it last year when UBS trashed its ETN lineup and issued duplicate Series B ETNs. We saw it when Deutsche Bank (DB) called eight ETNs for redemption three months ago. As mentioned earlier, Credit Suisse liquidated the $508 million in the CS X-Links Cushing MLP Infrastructure ETN in November, but apparently that did not go far enough, and so we now have the UWTI and DWTI debacle. Meanwhile, Credit Suisse says it decided to delist “with a view to better aligning its product suite with its broader strategic growth plans.”

The Financials sector continues to post the strongest momentum, while Energy is staking its claim as “most improved” in the relative strength department. This is the sixth consecutive week with Financials sitting in the top-ranked position. Energy jumped from seventh to second as oil prices shot higher on the OPEC production cut agreement and oil- and gas-related equities came along for the ride. The rise of Energy places the three “smokestack” sectors of Energy, Industrials, and Materials in the upper tier. President-elect Trump has vowed to restore the country’s manufacturing base, and the stock market is starting to price that in. Utilities, Health Care, Real Estate, and Consumer Staples are registering negative momentum again this week, and investors have classified these four as “defensive” sectors at one time or another. Most of these were near the top of the rankings in February, so the market has undergone a massive defensive sector to smokestack sector rotation this year.

Small Size was challenging High Beta for the top-performing investment factor a week ago, but High Beta has now opened up a substantial lead. Value picked up momentum this week and is now running neck-and-neck with Small Size. Fundamental rounds out the top-four performing factors, but strength starts to fade quickly in the lower half of the rankings. Yield and Growth barely managed to post positive momentum scores today, while Low Volatility and Momentum slipped back into the red.

On the strength of Energy, Canada propelled past the U.S. to capture the top global ranking. Don’t give up on the U.S. though, as it is in a strong second-place position and one of only five major global categories in the green today. The strongest categories all have a developed-market bias, and the three developed-market categories that are still in the red all posted strong gains for the week. The U.K., EAFE, and Eurozone are now on the verge of crossing back into positive momentum territory, leaving the three developing markets on the bottom. Latin America was top-ranked four weeks ago, and it sits at the bottom today. Although most of the damage occurred during the first week, it took another three weeks for Latin America to complete its downward journey in the rankings.


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

“Is there a future for investment banks in Europe? I think there is, but it comes from the outside. They need to merge and re-incorporate outside Europe. You could maybe merge one or two big banks, the rest will have to liquidate.”

—Eric Knight, principal at activist investor Knight Vinke

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