Commodities and Endowment Investing

A reader passed along a link to a Hard Assets Investor interview with Mebane Faber that was mostly about his new book The Ivy Portfolio. I have a copy of the book but need to apologize for not having had time to read and review it.

There is one point in the interview that I wanted to explore and perhaps we can elicit a response from Mebane.

In response to a question about how to access the commodity space, Mebane says "...and in commodities and currencies, we think long/short makes more sense than long/flat." He goes on to say "To access the space, we use the managed futures ETN [the ELEMENTS S&P CTI ETN (NYSE Arca: LSC)); Claymore is now putting out an ETF on the same index. We really like the managed futures product."

He says that in the book he talks about broad commodity index for commodities. In the chart I have LSC compared to the iPath Commodity ETN (DJP) and PowerShares Commodity ETF (DBC) for the life of LSC. I don't think anyone could have too much of a gripe about the performance of the fund but it does not look like a proxy for commodities to me.

If you look at a chart for Rydex Managed Futured (RYMFX), which is similar to LSC and has been around about 15 months longer, compared to DJP and DBC you will see that it too does not really look like a commodity proxy. I believe in what LSC does (I own RYMFX personally and for clients) but I would not expect a long/short vehicle to fully capture the reflation trade or any other commodity effect. In fact since the March low, DBC is up 6%, DJP is up 8% and LSC is down 10%.

Mebane makes another point that I agree with about replicating hedge funds and private equity. He says that thus far the ETPs out there are imperfect, although I would note that the Index IQ Hedge Fund ETF (QAI) is too new to render a verdict yet. And as I mentioned the other day Index IQ filed for a bunch of other hedge fund replication funds. If some of them deliver as hoped, then that would be an evolutionary step toward recreating the endowment portfolio for those so inclined.

Comments

[Mad Hedge F...:]

Those who followed my recommendation to buy copper on January 5 are the happy participants in the first bubble of the year. The red metal has rocketed from $1.28 to $2.26, while producer Freeport McMoran (FCX) soared 88% from $25 to $47. Heavy and secretive stockpiling of the red metal by China, which accounted for a third of the world’s 18 million tons of consumption last year, has been a main driver. Heavy buying by commodities based ETF’s provided the turbocharger. It is time to take some money off the table. Asset markets everywhere have suddenly gotten way too healthy, with global equity markets alone tacking on $7 trillion in value in six weeks. No one ever got fired for taking a profit, especially in this angst ridden environment. Of course, longer term I expect copper to rise past its all time high of $4.10, and for FCX to vault above its old high of $122, as we make the irresistible shift from a paper to a hard asset backed world. But it’s going to take more than a short covering rally in financial markets to get back up there. Better to buy it back lower.

Apr 20 10:55 AM

[rdd:]

I own LSC. It is doing just what I bought it for: a long-term investment diversifier with little correlation to anything.

It is designed to follow trends that take several months to turn around so its performance is poor at topping and bottoming points but does well in the subsequent rise or fall.

I read the rationale about not shorting energy before I bought it and it makes sense to me for the purpose for which I bought it. I didn't want to own it if I would have to bail out of LSC just because somebody bombs a pipeline someplace. I am currently long oil through a holding in USL and GSG, both of which I bought at the end of 2008 and early 2009, and are intended to be relatively long-term holdings as an inflation hedge. If the commodities start to look bubbly like they did last year, then I plan on dumping those holdings but hang on to LSC as long as HSBC stays healthy so the ETN note is credit-worthy.

It is not designed to be a trading vehicle since it would be a lot of work to predict the daily and intraday moves since it is long and short various commodities at any given time. Anybody doing short-term trading should be just doing it with the individual ETFs for an individual commodity or with futures themselves.

Apr 20 02:12 PM

[SimpleVesting:]

Agreed that LSC seems to be a different asset class from commodities. Perhaps it needs it's own allocation? Maybe a split 10%/10% between DBC and LSC.

Apr 20 03:36 PM

[oldman:]

Why would anyone own an ETN with its shortcomings? Is the added credit risk worth it?

Apr 21 11:04 AM