good read......................
ETF INVESTING
Commodity ETFs forge ahead
Sector cools, but planned offerings look to success of oil, metals funds
By John Spence, MarketWatch
Last Update: 12:01 AM ET Jun 5, 2006
BOSTON (MarketWatch) -- Oil and precious-metals prices have lost momentum recently, but that isn't stopping exchange-traded fund providers from pressing forward with more commodity-related products.
"There's plenty of room for more commodities," said Cliff Weber, senior vice president of the ETF marketplace at the American Stock Exchange.
Among ETFs in registration is a fund from Barclays Global Investors, the largest ETF sponsor, designed to track the Goldman Sachs Commodity Index. Other providers have oil-linked ETFs in registration.
Meanwhile, Deutsche Bank AG (DBdeutsche bank ag namen ord
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DB ) is looking to follow its Deutsche Bank Commodity Index Tracking Fund (DBCdb commodity index tracking fd unit ben int
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DBC ) with new commodity-linked products. Those ETFs are still on the drawing board and not yet filed with regulators, said Kevin Rich, chief executive of DB Commodity Services LLC.
The Amex's Weber noted pent-up demand for commodities ETFs as diversification tools and to hedge geopolitical risk. The next step could be a move away from indexed approaches to more active strategies, and the Amex also wants to list options on commodity ETFs, he said.
There are currently five U.S. listed commodity ETFs, which collectively trade more than 8 million shares daily and hold about $10 billion in assets, Weber said on a recent industry conference call hosted by Institutional Investor.
The first domestic commodity ETFs -- StreetTracks Gold Trust (GLDstreetTRACKS Gold
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GLD ) and iShares Comex Gold Trust (IAUishares comex gold tr ishares
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IAU ) -- came to market less than two years ago. The trusts hold bullion in a vault while investors trade shares representing a fraction of an ounce of gold. Sibling iShares Silver Trust (SLVishares silver trust ishares
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SLV ) allows investors to own and trade silver without purchasing and storing the metal, or opening a futures account.
In February, commodity ETFs took a major step forward when the Deutsche Bank Commodity Index Tracking Fund began trading on the Amex. Like the exchange-listed metals trusts, the fund isn't a "true" ETF because it's structured as a commodity pool rather than a registered investment company, although it resembles an ETF in certain ways.
The Deutsche Bank fund was the first ETF-like product to invest in a broad basket of commodities through the use of futures, which industry observers expect say could open the floodgates for more commodity offerings. It invests in crude oil, heating oil, aluminum, gold, corn and wheat.
Then in April, the first ETF allowing U.S. investors to put money directly on the price of crude, U.S. Oil Fund (USOunited states oil fund lp units
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USO ) , launched on the Amex. It uses energy futures contracts, cash-settled options and other instruments to achieve the oil exposure. See full story.
Similar to the Deutsche Bank ETF, the oil fund holds Treasury bills as collateral, which also supply a yield used to offset management fees.
Bubbling over
Some observers have suggested these unique ETFs are fundamentally changing commodity markets because they allow new players, particularly individual investors, into what had been a difficult niche to enter.
Michael Lewis, global head of commodities research at Deutsche Bank AG, said commodities are gaining more credibility, likening them to the status of emerging markets in the mid-1980s.
"Back then few investors had exposure to emerging markets, but today no portfolio would be complete without them," he said.
One of the oft-repeated benefits of commodities is diversification, since the sector tends not to have much relationship with the performance of more traditional asset classes such as stocks and bonds. Strong global growth, rising interest rates and higher inflation are seen as bullish signs for commodities.
Still, both commodities and emerging markets are known for their above-average risk, and financial advisers generally recommend that each represent no more than about 5% to 10% of investors' portfolios.
The volatile nature of commodities has been driven home in the past few weeks. The two gold ETFs, for example, fell about 4% in the four weeks through June 1 and the silver trust plunged more than 13%, according to investment research firm Morningstar Inc. Meanwhile, the Deutsche Bank commodity basket lost almost 3% and the volatile oil ETF is also in negative territory.
Tough roll
Some commodity ETFs are also dealing with structural issues. Both U.S. Oil Fund and the Deutsche Bank commodity basket broke new ground because of their use of futures, but investors are learning the approach also has its drawbacks due to the need to continually "roll" the contracts.
Rather than take delivery of the physical commodity, these ETFs sell the near-dated contract and purchase a longer-dated one to maintain the exposure.
This activity can create so-called roll return, both positive and negative, on top of the movement of the spot price and the yield from the bond collateral.
In a situation known as "contango," the longer-dated contracts are trading at a higher price then the shorter ones. In this environment where traders expect more expensive future prices on supply and demand issues, commodity ETFs would suffer a negative roll return.
Conversely, when the futures with the more distant expiration date are trading cheaper, the market is said to be in "backwardation."
Highlighting the risk of roll return, the Deutsche Bank Commodity Index Tracking Fund announced last month that it was slightly altering the way it rolls futures contracts to fight the damaging effect of contango. The ETF now has more flexibility to roll into the futures contract which generates the highest roll return, rather than simply using the next month's contract, for example. See full story.
As a result, the ETF "is able to potentially maximize the roll benefits in backwardated markets and minimize the losses from rolling in contangoed markets," according to a regulatory filing.
