Leveraged Oil ETF UCO Is Fully Valued At $30

David Dierking

It's been about a month or so since I last wrote about the ProShares Ultra Bloomberg Crude Oil Fund (UCO) and its non-leveraged counterpart, the United States Oil Fund (USO).

My last article was in defense of why UCO wasn't headed to $300 any time soon and the one before that was to lay out my case for why UCO had little upside from its price at the time.

Back in May, I thought UCO could hit about $24 based on short-term momentum. It exceeded that level and managed to push up to $30, where it's flatlined for the past month.

Time to revisit the investment case for UCO again. And it's not a whole lot different than last time. In fact, it's more bearish.

No Value Left In UCO

My price target last time was predicated on the idea that the number of daily new coronavirus cases was declining and the economy was fully in the process of reopening. That would, in theory, increase the demand for energy as consumers get back to traveling for work, travel and other things.

It's safe to say that's no longer a reasonable expectation.

Cases in the U.S. are skyrocketing and hot spots, including Florida, Texas and Arizona, are closing businesses back up and restricting travel. While a full-scale shutdown still appears unlikely (for now, at least), the U.S. economy is no longer on the recovery track.

That's already shown up in cyclical stocks, which for the past month have been badly trailing the S&P 500.

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So far, that pessimism hasn't been showing up in oil prices. Despite the problems arising from the COVID outbreak, oil has remained steady around the $40 level and hanging in a very tight range.

CLY00_Barchart_Interactive_Chart_07_14_2020

For the most part, the performance of USO and UCO has reflected the behavior of oil. After a brief spike in mid-June, both have remained fairly flat.

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Where Does UCO Go From Here?

At this point, I believe the macro environment for oil is deteriorating and there's more downside than upside here.

Declining consumer demand for energy is already showing up in the data. Airline passenger travel is down. Dine-in restaurants are experiencing a decline in foot traffic. Unless there's an unusually cold winter that requires an increase in heating fuel, there doesn't appear to be an immediate catalyst for a move in oil prices above $40.

The fact that the recent production cut agreement is about to expire (or at least reduced) should further impact the supply/demand curve for crude. Saudi Arabia is already about to ratchet up production. Russia is expected to follow suit shortly as well. $40 oil makes crude production far more profitable than it did a few months ago, but another supply glut could drive prices right back down regardless of the economic environment.

Forecast

Right now, I wouldn't be at all surprised if crude oil futures contracts dipped back down to $30. It won't be a full scale crash like it was back in April as I expect consumers will be anxious to maintain some form of normalcy in their lives.

If you combine a drop in expected economic activity with production increases from multiple OPEC+ nations, it's an easy case to be made for lower oil prices.

As far as UCO is concerned, it appears to have maxed out around $30. The fund should experience less volatility to the downside than before given its new exposure to longer-term futures contracts, but that will only mitigate a small portion of the downside.

If oil drops to $30, I'd expect UCO to fall to around $21. If you're into USO instead of the leveraged UCO, a move back to the $23 range is a reasonable expectation.

In short, I would be avoiding oil funds here for the foreseeable future.

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