The proliferation of commodity ETFs has brought this “fourth asset class” within reach of more investors than ever before. But as many have learned the hard way, resource fundamentals are only one of the factors that impact many exchange-traded commodities, and the nuances of the futures market often have a more significant impact than changes in spot prices. Most ETF investors looking for commodity exposure do so in one of two ways: 1) physically-backed or futures-based commodity products (such as GLD or DBC) or 2) equities of commodity producing companies. But some have embraced international funds as a way to achieve indirect commodity exposure while maintaining some degree of diversification in emerging economies. Below, we profile some alternative ETF options for investing in commodities.
A recent report from BusinessWeek details the largest producers of some of the most important metals to modern life. While not always directly correlated, the prices of precious and industrial metals often have a material impact on the equity markets of resource-rich countries (just as high oil prices can translate into plush government coffers for OPEC countries). Many emerging markets are tilted towards commodity-intensive equities, meaning that changes in natural resource prices can improve the profit margins for a big slice of the economy. But there’s also a ripple effect: increases in commodity prices bring more money into the country, which can boost consumer companies, financials, among others.
Chile / Copper
Despite the relatively small size of the country, Chile is a copper powerhouse, producing roughly one-third of the world’s total output. Copper is vital to the modern construction and electrical industries due to its use in wiring, integrated circuits, and piping. The wide variety of applications for the metal and its relatively cheap price ensures that demand remains strong for the metal. Furthermore, should the world economy pick back up, demand for the industrial metal could increase as construction and infrastructure projects pick up in emerging markets.
The Chilean market can be accessed by investing in the iShares MSCI Chile Index Fund (ECH). Almost 30% of the fund’s assets go to utilities, with 20% to both industrials and materials. ECH has performed very well over the past year, surging higher by more than 50%. Copper, as represented by iPath DJ-AIG Copper Total Return Sub-Index ETN (JJC) has done even better, gaining more than 100% over the same period. These trends have reversed in 2010, with ECH outgaining JJC by 3% to -1%. Since its inception in 2007, ECH has exhibited a correlation with JJC of about 0.5.
Peru / Silver
Producing nearly one-fifth of the world’s total, Peru is an important player in the global silver market. In addition to being a store of value, silver has several industrial applications as well. Most importantly, silver is very efficient at absorbing solar energy, which helps to make silver coated solar panels some of the best in the industry. Furthermore, silver has various other properties that make it an excellent addition to many electronic components as well as medical applications. The numerous industrial applications give silver a different risk profile than gold, establishing a floor for demand and generally reducing volatility.
The Peruvian stock market can be accessed by investing in MSCI All Peru Capped Index Fund (EPU), which devotes an impressive 65% of its assets to the material sector. EPU has dramatically outperformed iShares Silver Trust (SLV) both over the past 52 weeks and in 2010. EPU is up about 30% over the past 52 weeks while SLV has only gained 12%. However, EPU charges investors an expense ratio that is 13 basis points higher than SLV and 33 basis points higher than ETF Securities’ SIVR. Since its inception, EPU has exhibited a correlation with SLV of nearly 0.80.
South Africa / Platinum
South Africa dominates world platinum production, producing 78% of this precious metal. Some reports estimate that within the next thirty years automobile usage will double, approaching 900 million cars. This could be good news for platinum investors, since nearly 50% of the world’s supply goes into producing catalytic converters. As more people drive and as environmental concerns grow in both emerging and developed markets, platinum demand could surge.
The MSCI South Africa Index Fund (EZA) is the best bet for investors that are looking to access the South African stock market. The fund is well diversified across different sectors, with the largest allocations to both financials and materials firms, each of which makes up more than 25% of the fund’s total assets. The ETF Securties Physical Platinum Shares (PPLT) is a relatively new fund, so measuring the correlation between these funds isn’t meaningful yet.
Russia / Palladium
Russia, a longtime natural gas leader, is also the largest producer of palladium, responsible for 50% of the world’s total. Palladium is heavily used in catalytic converters like its more expensive cousin, platinum. Due to its steep price discount to platinum, as well as its superior performance in reducing diesel particulate matter, many are looking to expand the use of palladium in converters for diesel engines.
Russian equities can be accessed by investing in Market Vectors TR Russia ETF (RSX). Although the Russian ETF has a very large allocation to energy firms (42%), it does have a big weight towards materials as well, with this sector making up 24% of the fund’s assets. RSX has surged over the last year, gaining nearly 200%, due largely to an improved outlook for the oil and gas sector, but owing partially to strong pricing for palladium, nickel, and other industrial metals that are found throughout the country.
To read more on the top producers for various metals, see the full report from BusinessWeek.
Disclosure: No positions at time of writing