The Commodities ETF Crackdown Continues

The threat of increased regulation from the Commodities Futures Trading Commission continues to impact the ETF industry. Increased position limits are designed to reduce the impact that ETFs such as United States Natural Gas (UNG) have on the price of the commodities they are designed to track. The latest chapters in the futures regulation saga are the shuttering of PowerShares DB Crude Oil Double Long ETN (DXO) and the reconfiguration of the PowerShares DB Agriculture (DBA) and PowerShares DB Commodity (DBC) ETFs.

DXO was truly a victim of its own success. This leveraged exchange-traded note became so large that it was subject to limitations placed on its underlying components. Deutsche Bank considered the crackdown a “regulatory event” and redeemed the $407 million in outstanding notes on September 9. Its opposite, the PowerShares DB Crude Oil Double Short ETN (DTO), continues to trade.

Rather than shutting down futures-based DBA and DBC, two other popular commodities ETFs from PowerShares and Deutsche Bank (DB), fund managers decided to restructure the underlying portfolios in order to stay within position limits. The CFTC altered the course of these two funds with new “safety position limits” and the revocation of an exemption that previously governed the fund’s futures-buying capabilities.

The closing of DXO and restructuring of DBA and DBC represent a critical point in the development of the ETF industry. Regulation, not methodology, is shaping the capabilities of these exchange- traded products just as they are reaching new heights of popularity.

Nevertheless, new restrictions on futures-based commodity products will likely not stem the growth of the commodities ETF industry as a whole. While futures-based products are closed or restructured, issuers will continue to introduce new products without limitations.

Physically backed ETFs such as iShares Comex Gold (IAU) could play a greater role in the ETF universe as investor interest in commodities increases and uncertainty hangs over derivatives-based products. ETF Securities, a global ETF issuer, recently launched both the ETFS Silver Trust (SIVR) and ETFS Gold Trust (SGOL) to compete with entrenched competitors like IAU and SPDR Gold Shares (GLD) in the U.S.

Jefferies has also jumped on the commodities ETF bandwagon with the launch of the Thomson Reuters/Jefferies CRB Global Commodity Equity Index Fund (CRBQ). Rather than owning commodities futures or physical stockpiles, this fund invests in a basket of commodities-driven equities. Owning an ETF like CRBQ that tracks companies such as ExxonMobil (XOM) or Potash (POT) will certainly provide indirect exposure to commodities, but it will be less of a pure play on prices than is a futures fund like DBC, and it will offer less diversification to this separate asset class.

For more than a decade, ETFs have offered investors inexpensive access to specific sectors and regions of the global economy that were previously difficult to access. Increased regulation and position limits may be good for investor protection in the long haul, but in the short term these changes are caustic to derivatives-based products. Until definitive regulatory action is taken, investors should stick with physically backed ETFs like IAU or equities-based products like CRBQ.

Comments

[Bob Mayo]

If each commodity ETF has a size cap, then we need more issuers. For instance, there could be 10 institutions that issue ETFs that track the DB commodity index, or perhaps 10 different indexes.

2009 Oct 14 05:55 PM

[Alan Young]

Splitting the fund into a bunch of smaller funds doesn't solve the underlying problem: too much investment capital chasing too small a resource, causing bubbles to form. This is what regulators are concerned about, and with some justification. As one example, UNG had already started to consistently lose money on roll dates, since it was such a large player in the gas-futures trade; other traders could simply front-run its trades. For another: a single hedge fund manager could decide to sell his GLD holdings, and crash the world price of gold, because the ETF has such a large portion of the float. That does not make a healthy market.

A couple of years ago, we all thought that owning commodities was an essential part of portfolio balancing. But just when we most needed assets that would not be correlated to the stock market, commodities crashed right along with stocks. Why? When traders sell their stakes, whether to meet redemption demands, margin calls, or just general bearishness, the non-correlation disappeared.

This "piece of the commodities pie" is no longer worth fighting for.

2009 Oct 14 10:21 PM

[Gold Bug]

Buy Commodity ETFs and Indexes Food Crisis Looms Jim Rogers
Source :
jimrogers1.blogspot.com

2009 Oct 14 11:08 PM

[derryl]

I agree with Alan Young. If you're not a commodity producer or consumer then buying and selling futures is 'speculating', which is a zero sum game for speculators as a whole.

Let's assume that producers and consumers will sell and buy at market clearing prices. If speculators add buy money into this equation they can raise prices. But when they try to sell to realize gains the additional selling they add to the market drops the price at least as far as their buying raised it. Some speculators can make gains, but ALL of these gains are simply the losses of the other speculators in this market. John Stuart Mill pointed this out in his "Principles of Political Economy" published over 160 years ago, and the arithmetic hasn't changed.

One thing that has changed, though, is that there is now a huge volume of US dollars in the US and floating around the world, and the dollar is devaluing. So to hedge against currency devaluation people buy commodities and keep their money in this market. So the price is kept elevated for an extended period and will only drop to its true market level when all the speculators sell and take their money out. Speculators may suffer some losses at rollover time but if those losses are less than the amount the dollar is declining their hedge strategy is still working for them.

Meanwhile the price of the commodities is held higher than the 'pure' market price, with suppliers enjoying all the gains.

2009 Oct 15 01:31 AM

[USisCorrupt]

ALL ETF's are just another Madoff in the making. You buy your paper Gold & Silver and I will Buy the PHYSICAL Gold & Silver as long as I am able to. Then we will see who will be holding the BAG in the end? Don't worry though, you will be able to burn all that paper to stay warm someday.

America's market's are one big JOKE!

I traded in my dollar assets for Gold, Silver, farm, guns, ammo, food. water, tractor and can sleep very sound at night.

2009 Oct 15 08:27 AM

[EMS News]

Derryl is correct here: US dollars were flushed all over the world during the long years the US ran a growing trade deficit. Now, the world is flushing these dollars out of FOREX holdings and banks and they have to buy something.

So they have been flooding the commodities markets since the summer of 2007. This has destabilized commodity markets and thus, the US has to demand changes so our sinking ship isn't swamped totally by this tsunami of former trade dollars.

This, incidentally, causes inflation in the US.

2009 Oct 15 08:38 AM

[orch88]

USisCorrupt is right 10/10.
The biggest sinners are the "bullion banks". They have shorted gold and silver nearly half the world can produce annualy. If they crashed the government will bail them out. Simple.
BUT why are they shorting???? Is the Fed or government behind all these mad activities??? USA and the Euro countries have been holding the prices of gold and silver for more than 30 years very successfully. But they have not guarded themselves against the change in wealth accumulation amongst other countries (Mainly BRIC). When chinese and indian and their respective governments starting to accumulate bullion, the end is near for paper economics

2009 Oct 15 08:53 AM

[Gold Bug]

Commodities to Watch - Gold and Copper
thecommodities-market....

2009 Oct 19 06:22 PM

[Johnni]

People dont like equity based commodity plays, because its not a "pure play"

People dont like future based "commodity plays" for regulatory reasons and due to roll over capital bleed during contango.

How do we make everybody happy or should we?

@Alan Young - quit a statement. I wonder if you a right!

2009 Oct 23 03:10 AM