The commodity tracker scene goes red hot with launch of new futures funds
Commodity tracker specialist ETF Securities has just launched a huge new range of exchange traded commodities or ETCs (their alternative to ETFs) focussing in on the futures markets for key indices and commodities. In all 29 new funds will be issued over the next few weeks, all of them focussed in the future price of either key commodities like gold, zinc or sugar or of a composite index such as Livestock or Precious Metals.
The first batch of ten index based funds has just been launched and they’re all listed in the table below.
Over the next few weeks ETF Securities will be launching a further 19 funds this time concentrating on individual commodities – the list of expected funds is below.
Academics have been crunching the numbers for a quite a few years and they’ve proved that the real money in commodities is not really to be made on spot prices – they’re too volatile - but on playing futures prices. One study by Profs. Edwin Elton, Martin Gruber and Joel Rentzler (“The Risks and Returns of Commodity Funds,” in the April 1987 AAII Journal) found that only 1% of total returns in the last few decades from commodities investing could be explained by the returns of either the commodity spot index or commodity futures index. What mattered was how well or badly the fund manager played the index or developed options strategies.
Another working paper by Gary Gorton and Geert Rouwenhorst of Wharton and Yale unpicked the total returns between 1959 and 2004 from a basket of commodities – the annual return was just 3.47%. Next they calculated that the equally weighted and annually rebalanced futures contracts for those assets which yielded a return of 11.18%. The authors found that most of this second return was from backwardation.
In laymans terms backwardation describes how markets try to price in future risk.
This is how it works...
Farmers want to protect themselves in the future against future price falls from their output. That means they sell future output to brokers at a discount to protect their income. That discount is effectively a profit to a bunch of speculators who were willing to offer price protection to a bunch of timid commodity producers worried about future prices. But what happens if producers suddenly decide that prices are NOT likely to fall in a few months, but in fact RISE ! Maybe they’ll cotton onto the fact that huge financial institutions have been making a huge fortune from holding onto these forward contracts in a time of rising prices. It gets worse. Maybe the producers will work out that not only have these institutions made a profit from the time discount, they’ve also been investing the underlying money to pay for the futures contracts in bonds that have yielded a tidy income on top.
Suddenly backwardation could, well, go backwards…..
As one leading economist pointed out “ in a market whose major propelling force is the demand for insurance against inflation, those who supply it will demand a premium. Goodbye Keynesian normal backwardation, hello . . . . forwardation? “
Or contango as it’s called, which is exactly what’s happening in key commodity markets around the world . Oil markets for instance look at the moment like they might be poised to enter a contango phase – with potentially disastrous affects on investors in backwardation contracts. Or maybe not – nobody in truth really knows for certain what will happen next but an awful lot of smart money is on backwardation diminishing.
Where that leaves this range of products from ETF Securities is anyone’s guess. They absolutely fulfil a key function in the commodity markets – allowing investors to make money on forwards contracts. The key question is whether this is the right time for private investors to start playing the game and that is a moot point - we suspect the prime consumers of these new products will be those hedge funds and investment bank traders.
The first batch of ten index based funds has just been launched and they’re all listed in the table below.
| Forward index commodity securities | LSE code | Reuters | Bloomberg | ISIN | SEDOL |
|---|---|---|---|---|---|
| ETFS Forward All Commodities DJ-AIGCI-F3SM | FAIG | FAIG.L | FAIG LN EQUITY | JE00B24DMC49 | B24DMC4 |
| ETFS Forward Energy DJ-AIGCI-F3SM | ENEF | ENEF.L | ENEF LN EQUITY | JE00B24DMD55 | B24DMD5 |
| ETFS Forward Petroleum DJ-AIGCI-F3SM | FPET | FPET.L | FPET LN EQUITY | JE00B24DMF79 | B24DMF7 |
| ETFS Forward Ex-Energy DJ-AIGCI-F3SM | EXEF | EXEF.L | EXEF LN EQUITY | JE00B24DMG86 | B24DMG8 |
| ETFS Forward Precious Metals DJ-AIGCI-F3SM | FPRE | FPRE.L | FPRE LN EQUITY | JE00B24DMH93 | B24DMH9 |
Over the next few weeks ETF Securities will be launching a further 19 funds this time concentrating on individual commodities – the list of expected funds is below.
- ETFS Forward Aluminium
- ETFS Forward Coffee
- ETFS Forward Copper
- ETFS Forward Corn
- ETFS Forward Cotton
- ETFS Forward Crude Oil
- ETFS Forward Gasoline
- ETFS Forward Gold
- ETFS Forward Heating Oil
- ETFS Forward Lean Hogs
- ETFS Forward Live Cattle
- ETFS Forward Natural Gas
- ETFS Forward Nickel
- ETFS Forward Silver
- ETFS Forward Soybean Oil
- ETFS Forward Soybeans
- ETFS Forward Sugar
- ETFS Forward Wheat
- ETFS Forward Zinc
Academics have been crunching the numbers for a quite a few years and they’ve proved that the real money in commodities is not really to be made on spot prices – they’re too volatile - but on playing futures prices. One study by Profs. Edwin Elton, Martin Gruber and Joel Rentzler (“The Risks and Returns of Commodity Funds,” in the April 1987 AAII Journal) found that only 1% of total returns in the last few decades from commodities investing could be explained by the returns of either the commodity spot index or commodity futures index. What mattered was how well or badly the fund manager played the index or developed options strategies.
Another working paper by Gary Gorton and Geert Rouwenhorst of Wharton and Yale unpicked the total returns between 1959 and 2004 from a basket of commodities – the annual return was just 3.47%. Next they calculated that the equally weighted and annually rebalanced futures contracts for those assets which yielded a return of 11.18%. The authors found that most of this second return was from backwardation.
In laymans terms backwardation describes how markets try to price in future risk.
This is how it works...
Farmers want to protect themselves in the future against future price falls from their output. That means they sell future output to brokers at a discount to protect their income. That discount is effectively a profit to a bunch of speculators who were willing to offer price protection to a bunch of timid commodity producers worried about future prices. But what happens if producers suddenly decide that prices are NOT likely to fall in a few months, but in fact RISE ! Maybe they’ll cotton onto the fact that huge financial institutions have been making a huge fortune from holding onto these forward contracts in a time of rising prices. It gets worse. Maybe the producers will work out that not only have these institutions made a profit from the time discount, they’ve also been investing the underlying money to pay for the futures contracts in bonds that have yielded a tidy income on top.
Suddenly backwardation could, well, go backwards…..
As one leading economist pointed out “ in a market whose major propelling force is the demand for insurance against inflation, those who supply it will demand a premium. Goodbye Keynesian normal backwardation, hello . . . . forwardation? “
Or contango as it’s called, which is exactly what’s happening in key commodity markets around the world . Oil markets for instance look at the moment like they might be poised to enter a contango phase – with potentially disastrous affects on investors in backwardation contracts. Or maybe not – nobody in truth really knows for certain what will happen next but an awful lot of smart money is on backwardation diminishing.
Where that leaves this range of products from ETF Securities is anyone’s guess. They absolutely fulfil a key function in the commodity markets – allowing investors to make money on forwards contracts. The key question is whether this is the right time for private investors to start playing the game and that is a moot point - we suspect the prime consumers of these new products will be those hedge funds and investment bank traders.
Labels: backwardation, commodity tracker, ETF
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