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Minyan Mailbag: Tracking Crude and Tracking Error

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It isn't error - just flaws in the fund's design.

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Professor Warner,

I own some of Powershare DB Crude ETN (DXO). I want to make a long-term investment in Oil, but I would rather go for a bigger gain than USO. Recently, crude is around $40 per barrel, and DXO closed around $2.55 on December 5th. Knowing that DXO tracks -200% or +200%, what happens if oil goes down to $20 per barrel (-50% from $40)? Does that mean this DXO will be $0 (minus 100%)?

Will this ETN implode? I know the ETN tracks indexes, and depends on the credit of the bank that issues the note. But if there's a danger of DXO being wiped out at $20 per barrel, I'm a little worried that the money I've already invested in DXO will be wiped out as well. I'm long for oil, so I have no problem with the current downturn, but if it can be $0 (a wipe-out), then I
am a little worried. Could you explain how DXO works?

Thank you so much for Minyanville's guidance.

- Minyan JJ

Minyan JJ,

The ETN tracks futures contracts on light sweet crude oil (WTI), and reflects the performance of crude oil.

And guess what? DXO has beaten expectations! Crude is down something like 70% in the past 6 months, and DXO has only lost 90%. Woo-hoo!

And it can never get to 0, unless crude drops over 50% in one day. Remember - this is reset each day.

With all that being said, I believe they do de-list somewhere along the way. But that too is above zero. So you're probably pretty close to a floor in DXO. Which I realize is a very bold statement about something with a full of "2." Maybe they can turn it into 3x crude, then ride a little oil gusher.

And since we've returned to the topic of double leverage, let me clarify the idea of tracking error, which I think is being increasingly misused to describe what happens to, say, DUG, which has gone nowhere amid an implosion in IYE, the ETF it ostensibly tracks.

That's not a tracking error - it's just the way the fund is designed. It's Compounding Gone Wild. Double-leveraged ETFs do no worse a job of tracking than, say, IYE itself, which tracks the Dow Jones Energy Index.

It's just the design itself that's flawed.

Yours,
Professor Warner
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