Not All Commodity ETFs Are Created Equal

“You have to understand accounting and you have to understand the nuances of accounting. It is the language of business and it’s an imperfect language, but unless you are willing to put in the effort to learn accounting – how to read and interpret financial statements – you really shouldn’t select stocks yourself.” - Warren Buffett

For commodity ETFs, the good news is that you might not need to understand accounting because there is no company’s 10Q for you to read. It is all about fundamental, supply & demand and U.S. dollar.

Below are the top 10 Commodity ETFs (by net assets) I compiled from Yahoo Finance:

Rank	Fund Name	Ticker
1	SPDR Gold Shares	GLD
2	iShares Silver Trust	SLV
3	United States Natural Gas	UNG
4	PowerShares DB Commodity Index Tracking	DBC
5	PowerShares DB Agriculture	DBA
6	United States Oil	USO
7	iShares COMEX Gold Trust	IAU
8	iShares S&P GSCI Commodity-Indexed Trust	GSG
9	iPath Dow Jones-AIG Commodity Idx TR ETN	DJP
10	iPath S&P GSCI Crude Oil Ttl Ret Idx ETN	OIL

To find undervalued commodities, I compared daily price of natural gas (UNG) and oil from Jan 13, 1994 through Aug 4, 2009. Data are from US Energy Information Administration (Source). Within these 3,892 trading days, the average Oil : Natural Gas ratio is 8.6 : 1. As you can see from the chart below, today’s ratio ( 18:1 ) is at the historical high.

Either oil is overpriced or natural gas is undervalued. For hedge, you might want to short United States Oil (USO) and long United States Natural Gas (UNG). But I don’t think NG price will stay in $3.5 - $4 range for long, even though there are plenty of supply, floats of inventories and lots of economic uncertainty. Below chart shows future price for NYMEX Henry Hub Natural Gas ( source: shttp://futures.tradingcharts.com/marketquotes/index.php3?market=NG_). As you can see, Dec 2009’s price is $5.43.

Pure commodity ETFs might not be a good long-term investment because they typically invest in futures contracts, options and indexes. If you want to invest in commodity related companies ETFs, below are the top 10:

Rank	Fund Name	Ticker
1	Energy Select Sector SPDR	XLE
2	Market Vectors Gold Miners ETF	GDX
3	Oil Services HOLDRs	OIH
4	Market Vectors Agribusiness ETF	MOO
5	iShares S&P North Amer Natural Resources	IGE
6	PowerShares Water Resources	PHO
7	Materials Select Sector SPDR	XLB
8	Vanguard Energy ETF	VDE
9	iShares S&P Global Energy	IXC
10	PowerShares WilderHill Clean Energy	PBW

Disclosure: I have long position in UNG.

Comments

[Dr. No:]

"Either oil is overpriced or natural gas is undervalued." This assumes a somewhat fixed offering and demand of oil to gas. Could be that all of a sudden more gas (or expectation thereof) is available (and gas got cheaper by more supply and same demand) and you now move from a 8.6 to 18.1 ratio.

Aug 12 01:47 PM

[Xyrus:]

It might make more sense to do two ratios with a common base. I'd do a ratio of gas to gold and oil to gold and plot those. I think that would paint a clearer picture.

~X~

Aug 12 03:18 PM

[Energy Trader:]

While oil and nat gas have an energy equivalent rating of 1:6 the ratio comparison does not make since. Chiefly b/c they are not perfect substitutes. This comparison is like comparing gold to diamonds. Someone who wants gold will not readily trade it for some comparable equivalent of diamonds. Ask any woman. In the same way someone who owns a car will not trade nat gas for oil to fuel the transportation needs. Oil is used for transportation and nat gas is used for electricity generation, for the most part.

Aug 12 10:32 PM

[FB5000:]

what about LSC - the long/short commodity ETF? Thoughts?

Aug 12 11:21 PM

[naturallight:]

Wow, so all we have to do is look at a futures table to see where prices are going to go? Remarkable. Let’s keep this a secret.

Aug 18 11:59 AM