Focusing on Commodity ETFs: Hyperinflation Seems Inevitable

The U.S. government has committed $7.8 trillion and spent almost $1.4 trillion according to a recent New York Times article, which used information from the treasury department and the Federal Reserve to break down U.S. commitments pledged to save us from the financial crisis. Will this lead to the ultimate demise of the dollar? If so, how would you set yourself up to profit from it?

Hyperinflation is a condition in which prices increase rapidly as a currency loses its value. While you could open up a currency account and simply short the dollar, I am going to focus on a few funds that are readily available to the average investor that doesn’t trade currencies. Purchasing real assets or commodities is one way to profit from rising prices so let’s take a look at some diversified investment offerings in the commodity arena (click to enlarge):

From a recent performance standpoint, the clear winner is the Greenhaven Continuous Commodity Index Fund, which has the lowest weighting to energy related commodities. I had a chance to talk with the founder of Greenhaven at the Inside Commodities Conference held at the NYSE in early November (see pictures from the event).

This fund is the only commodity fund that rebalances daily in an effort to maintain maximum diversification, which explains the slightly higher management fee. Relative to the other choices above, this is a good fund if you are not into high levels of volatility.

The iPath GSCI Total Return Index rang in with the highest allocation to energy related commodities and not surprisingly it had one of the worst percentage losses as a result of the drop we’ve seen in those commodities. The weighting of the underlying index is based on the average historical world production weights of the individual commodities, which explains the high weighting put towards energy related commodities.

The PIMCO Commodity Real Return Strategy fund racked up the worst loss, but charged the highest fee. With a one-star rating given by Morningstar you might be thinking “what sucker is going to buy this?” Looks can be deceiving; the fund provides exposure to the Dow Jones AIG Commodity Index, while placing small bets with individual commodities. For instance the fund may pair natural gas against oil to profit from the delta in price appreciation, but in addition to actively placing small bets on individual commodities, the manager also purchases treasury inflation protected securities (TIPS for short) rather than treasuries with the excess capital. This allows the fund to gain on not only commodity price increases, but inflation expectations as well. Unfortunately in this deflationary environment this investment strategy has resulted in a double whammy for PIMCO manager Mihir Worah.

When evaluating investments such as ETNs be sure to check and see that the issuer of the notes is credit worthy. While this may be easier said than done, it is worth at least making an attempt. Unlike ETFs, which hold the underlying securities, ETNs are debt instruments guaranteed by the issuer. If the issuer goes bankrupt, you could lose everything. Liquidity is also an important factor; some funds may have bid ask spreads as high as fifty cents per share so be sure to always use limit orders and try and split the spread.

*Six month performance measured from June 2, 2008-November 2, 2008

Source: Tracking the Bailout: The Government’s Commitments, NYT, November 26, 2008

Disclosure: no positions

Comments

[Jack K:]

Commodities make sense at the right time. But when is the right time? There are any inflationary indicators. Which one is most associated with a rise in commodity prices?
M1, M2, M3, gold, oil, food, dollar vs. Once they triple in price, it is too late to buy them.
They all have gone up at one point, without significant inflation.
What do you think, Keith?

2008 Dec 02 07:31 AM

[Fed up:]

Just curious. Why didn't you include iSHARES S&P GSCI Commodity Index-ETF (GSG) ?

2008 Dec 02 11:33 AM

[cma cma:]

DBC is also an ETN, I believe, sponsored by Deutsche Bank.

2008 Dec 02 12:52 PM

[Xyrus:]

Incorrect. DBC is an ETF.

~X~


On Dec 02 12:52 PM cma cma wrote:

> DBC is also an ETN, I believe, sponsored by Deutsche Bank.

2008 Dec 02 01:57 PM

[fran:]

track the CRB index[or any other long lived multi-commodity index of choice]vs inflation indicator or falling $ value indicator over recent history[25 to 50 yrs]. the answers to questions will be evident.


On Dec 02 07:31 AM Jack K wrote:

> Commodities make sense at the right time. But when is the right time?
> There are any inflationary indicators. Which one is most associated
> with a rise in commodity prices?
> M1, M2, M3, gold, oil, food, dollar vs. Once they triple in price,
> it is too late to buy them.
> They all have gone up at one point, without significant inflation.
>
> What do you think, Keith?

2008 Dec 02 02:20 PM

[jepittman:]

Hyperinflation is no more inevitable than deflation. Both are conditions determined by the supply of money which is controlled by the Federal Reserve. There have always been cycles of inflation an deflation but prolonged destructive hyperinflation or deflation are caused by protracted errors in monetary policy. Many believe such is happening now but the evidence is that the Fed is increasing the money supply to offset declining prices. As prices stabilize and begin to rise again the Fed should act to reduce the money supply. The hyperinflation you seem to forsee depends on a negligent monetary policy. That is not inevitable although it could happen.

2008 Dec 02 09:34 PM

[Keith Robison:]

The former manager of the PIMCO commodity fund told us that his feeling in early November was that we still have another one or two quarters of deflation. Nobody knows for sure, so many people have been wrong, but I'm waiting for a break in UUP and FXY. Until then I'm not going to try and pick a bottom. I believe the best inflation indicator is probably the dollar.


On Dec 02 07:31 AM Jack K wrote:

> Commodities make sense at the right time. But when is the right time?
> There are any inflationary indicators. Which one is most associated
> with a rise in commodity prices?
> M1, M2, M3, gold, oil, food, dollar vs. Once they triple in price,
> it is too late to buy them.
> They all have gone up at one point, without significant inflation.
>
> What do you think, Keith?

2008 Dec 02 09:36 PM

[Keith Robison:]

I wasn't aware of GSG, but it seems very similar to GSP. I should have included LSC, which is an interesting long/short commodity ETN.


On Dec 02 11:33 AM Fed up wrote:

> Just curious. Why didn't you include iSHARES S&P GSCI Commodity
> Index-ETF (GSG) ?

2008 Dec 04 01:09 AM

[Looking at ...:]

Keith, why didn't you include LSC it's performance was head and shoulders above all the others. The six months June to December total return was + 6-8%. For the year 2008 the Commodity Trends Indicator (which the LSC tracks) was + 17.70%. No contest vs. the long only options!

Apr 10 09:57 PM