Oil and Gas ETFs: Dirty Truth

I could also try to explain how ETFs contribute to the flow of capital from Americans into the coffers and sovereign wealth funds of oil-producing nations that aren't entirely sympathetic to our way of life, but it would fall on deaf ears.

Instead, since the trading volume of these commodity ETFs continues to increase, let me tell you why you're not getting the investment you think you're getting and at least how to keep yourself as safe as possible while you're trading them.

When you buy or sell USO or UNG, you generate orders electronically in the futures markets for oil and natural gas.

While those orders move prices in the futures market, they also get reflected back to the price of the ETF. The idea is for each market to move perfectly in lockstep so you can use the ETF as a proxy for the futures market.

But it doesn't work out that way. Futures aren't stocks.

For one thing, they don't have a set number of "shares." With a stock, there's a known "float" that investors must "fight" each other to possess. That's how value and price are discovered. But futures theoretically have no limit to the number of contracts that can be written. Price and value are intended to be discovered in another way, and ETF trading can distort those mechanisms.

Futures also have a curve of monthly delivery contracts, and the reported price you see is the price for the first month only, the "spot month," which has a lifespan of at most 30 days. After that time, all contracts in the ETF that haven't been liquidated need to be "rolled forward" and try to reflect the next month out on the curve -- the one now becoming "spot."