By Drew Voros
Below, the CIO for United States Commodity Funds weighs in on an SEC study associated with proposal for a physically backed copper fund.
The JPMorgan XF Physical Copper Trust -- a JPMorgan fund that is currently in registration at the Securities and Exchange Commission -- would be the first ETF to be backed by physical copper, much like the SPDR Gold Fund (NYSEARCA:GLD) holds gold bullion. The SEC may rule on whether the fund can go to market as soon as Thursday, or the review could be extended again. HardAssetInvestor's Drew Voros caught up with John Hyland, chief investment officer for U.S. Commodity Funds, to discuss the regulatory review and, more specifically, an SEC study that examined the impact of metal ETFs on prices.
HAI: Do you agree with the SEC’s recent study that says ETFs do not move metal prices?
John Hyland: I agree with their conclusion, but I think there is a flaw in the presumption that led to putting together the study. The presumption they are making is that if GLD owns $60 billion worth of gold, that somehow that gold is not on the marketplace and that it’s somehow being hoarded; whereas, if a central bank bought that same $60 billion worth of gold, somehow it is in the market.
But we know that the exact opposite is true, that GLD’s gold is absolutely available to the marketplace. Any large player can buy that physical gold right out of GLD and take delivery of it, if they so choose, which they cannot do if the same $60 billion or $70 billion was owned by the Central Bank of Singapore.
I would argue that the only gold in London that is fully available to the marketplace is the gold held by the ETFs, because they're the only ones whose mandate requires that they sell the gold to you in exchange for you providing them the shares.
HAI: They're creating, they're redeeming and you see the flows. Some days there's $250 million flowing out of GLD. And that’s $250 million worth of gold flowing out, right?
Hyland: All that’s really happening is that in these vaults that are operated by HSBC or JPMorgan or UBS or whomever, you’ve got all these stacks of gold that never really go anywhere. Although this isn't actually how they do it, I like to visualize that every stack of gold has a little Post-it note on it saying, “Today this gold belongs to the Central Bank of Singapore.” And then the next day, the tag gets replaced and says, “Today this gold belongs to GLD.” The gold actually doesn’t go anywhere. Just the little Post-its move around.
But only GLD and the other physical metal ETFs are the only real participants in these markets that are bound every day to buy or sell gold. They're the only physical players in those markets that have to provide access to their stockpile to anybody who shows up with 100,000 shares worth.
But if you get into platinum, palladium or silver, where you have larger percentages of the activity there involving the auto industry or other industries, you could make the argument. That’s a little different. But even then, it doesn’t make sense. Because, once again, SLV [iShares Silver Trust] has to sell the silver, the physical silver, to whoever wants it. They're going to have to pay the then-going price. But SLV cannot hoard silver. Anybody can have it who wants to cobble together an order.
Then you get to copper. And people say, “Well, copper is different than gold.” OK, you see the point, gold just sits there. And copper doesn’t. But I say once again, remember, at present, every institutional player in copper can buy copper, store it in an LME warehouse, or store it in a non-LME warehouse, and refuse to sell it to anybody else, no matter what happens to the price. That is how that market works. That is how basically all commodities work. You just hold onto it if you want, except for the proposed physical copper ETF. It would be the only participant who cannot hoard copper.
So it’s actually laughable that you have this lawyer representing these physical copper traders who are exactly the people who are capable of hoarding copper by buying it, not selling it into the market, because they want to hold onto it, even though they may not have a particular physical need for it from industrial standpoint. And yet they're the ones who are turning around saying, “Oh, these guys are going to be hoarding this stuff. These guys are going to be manipulating the market.” I’m sorry, I don’t think a physical copper ETF is a logical candidate for anybody to manipulate the physical copper market.
HAI: Let’s move to the actual copper fund itself. Obviously, this would be competition to your futures-based United States Copper Fund (NYSEARCA:CPER).
Hyland: I think of it more as a complement.
HAI: Do you support the proposal?
Hyland: Yes. Because what it would allow investors to do is to trade a physical ETF versus a futures-based ETF, which potentially might benefit liquidity in both of them. I am not, in principle, objecting to a physical copper ETF. Because, No. 1, I don’t at all believe the argument that it creates physical scarcity. That’s nonsense. And No. 2, it would actually give investors the ability to trade both copper futures and physical copper. This now makes that possible for both.
On the other hand, I think one of the unavoidable limitations of this particular ETF, or any physical commodity ETF other than the precious metals, is that they are simply going to be faced with the reality that storage costs on commodities, other than physical metals, are pretty steep. Copper is probably around 250 to 300 basis points.
I do not know what storage rate either JPMorgan’s physical copper ETF would end up paying, or what the iShares proposal is going to pay. The last time I looked, neither of those prospectuses had disclosed the rates, which is an enormously important number.
Unless copper is in contango by more than 400 basis points annualized, this is actually not as good a deal as just buying the futures. But we know that, over the next 10 years, there will be times when copper is in backwardation; in which case you do not want to own the physical copper ETF—you would rather own the futures-based product. And then there will be times when copper is more steeply in contango and people would prefer the physical product. So I don’t see a problem with having the physical one out there.
But I raise a question: How big a market is there for it? And there is something we see in some of these press releases that is designed to scare people about the impact of this that is misleading. The deliberate use of the total number of shares being registered as being indicative of the expected size of the fund at any given time is misleading.
When I register shares for something like USO or UNG, I register 1 billion shares at a crack. USO or UNG might only have 40 or 50 million shares outstanding at any given time. But with ETFs that are ’33 Act ETFs -- which would be all of the commodity ETFs -- you only get to use a share once. So if USO has 40 million shares outstanding, and every week I get a couple million shares created and a couple million shares redeemed -- let’s say 2 million shares -- then at the end of the year, I've gone through 100 million shares.
The total number of shares you register is not the size of the pool that you think it’s going to be on day one, or year-plus-a-day-one; it’s just a number. They're deliberately trying to conflate the number of shares that are being registered, which is probably more indicative of how many shares they think they might go through in and out, in and out, over three years, with the maximum size. I actually think it’s very unlikely that a physical copper ETF is going to, in the U.S., in the next couple of years, be larger than $100 or $200 million at any given time. It’s hard to imagine that you're ever going to break $1 billion [in AUM] on copper.
Copper is not gold. They just don’t have the same resonance. And you have the problem that, as long as copper is in backwardation -- and copper spent a lot of time in backwardation over the last 10 years -- people aren't exactly going to be flooding into this physical fund.
HAI: Let me ask you about CPER, your copper futures fund. Tell me how you think it’s been going now. It’s been on the market for what, nine months?
Hyland: It’s been nine months. The timing was not ideal. Copper has been in a bit of a slump for more than nine months. With a new product, that’s not helpful. There is no other copper ETF in the United States, but there was a pre-existing copper ETN. It’s been tough sledding.
Where you would expect to see an uptick in people’s interest is when investors start to firmly feel that China is going to start regrowing its economy after a little bit of a slowdown here, and starting particularly in the areas of electrification and real estate construction, which are both huge consumers of copper. People right now are sort of obsessing about the U.S. “fiscal cliff.” But I think there's going to be a point when people say, “China is on a roll again. And which commodities are going to be looking good for that?” And you look around. And copper’s name usually comes up to the list.
HAI: Are you thinking about any more metal funds? I mean is that something you can even talk about?
Hyland: We don’t have anything in registration on metal funds. We’ve got one at the diversified basket [United States Metals Index (NYSEARCA:USMI)]. And we’ve got one for copper. So the question is, How many baskets do you need?
HAI: And do you think the industry needs another metal fund? Is there room for another physical gold fund?
Hyland: Precious metals are pretty well represented. There are only really four, and each one has at least one ETF variation. You can bring out more there, but probably not a huge opportunity.
It’s the same with the industrial metals space. Are there a lot of people out there who really want to trade tin, lead, nickel? Not enough to justify a commodity ETF. With single commodities, once you get past copper, I don’t know at present if there's really enough embedded interest on the part of investors that you would actually go out and bring out a nickel fund or one of these others.