The Newest Commodity ETF: Take Other Side of Bet

Jul.28.10 | About: Global X (LIT)

Click to enlargeIn Tuesday's issue of Resource Prospector, I talked about the idea of shorting new commodity ETFs. There's lots of evidence that new ETFs, especially commodity ETFs, are launched at the height of their popularity, and they can only fall from those heights.

There are a few exceptions, and I will be publishing a special report about my three favorite ETFs - funds that are actually designed to make money, not lose money - in sectors that I think have plenty of upside.

If you haven't read my commentary on ETFs before, and you're wondering why firms would launch funds that tend to underperform, all you have to do is look at this simple chart to the right, and you'll understand.

Every ETF has an expense fee, usually somewhere between 0.25% and 0.75%. So, every time Wall Street sells another $1 billion in ETFs, they're taking $2.5-$7.5 million off the top - just for having the brilliant idea to sell the public something they're dying to own. Money has been flying into ETFs, and no firm wants to be left behind. So they're launching funds based on anything they can think of - regardless of how good of an idea it is to actually invest in.

That is why I'm looking for opportunities to short these funds, and I've found a slam-dunk shorting opportunity. The ETF is in a sector that I have long railed against as "popular." It has lots of approval and support from politicians, the media and celebrities, but very little fundamental basis for investment.

As if another handful of nails in the coffin weren't necessary, the investment in question is a commodity ETF. Time and time again, when a commodity ETF gets launched at the height of its popularity, it presents an excellent shorting opportunity. Right now, I challenge you to think of a sector that's hotter than lithium. Like the housing market before it, and dot-com stocks of the late 1990s, lithium is a "sure-fire bet." We're told it's different this time, because lithium is the battery of the future.

Well, we all still live in houses, and use the internet more than ever, but that's small consolation for investors who saw their savings go up in real estate and dot-com smoke. Today, lithium is the must-have ticket to a future of stock-market riches.

  • Tesla Motors (NASDAQ:TSLA), the lithium-battery powered car company, just went public two weeks ago.
  • Earlier this month, Nevada Senator Harry Reid announced the expansion of lithium production in a Silver Peak, NV mine.
  • General Motors still isn't yet publicly traded again, but they just announced that their lithium powered plug-in car, the Chevrolet Volt, will cost $41,000 when it finally hits showrooms later this year.
  • According to a story in the San Francisco Chronicle, buyers of electric cars (most of which are powered by lithium-ion batteries) are eligible "to take advantage of a $7,500 federal tax credit and, in California, a $5,000 state rebate."

So, California residents will essentially get a $12,500 discount on any new electric cars they buy. The two rebates combined are more than 50% higher than the federal government's first time home buyer tax credit...

I don't know about you, but even the $7,500 federal tax credit strikes me as completely ridiculous. Since when is the federal government capable of, let alone responsible for, subsidizing automobile sales? I understand that a good chunk of the aforementioned GM is still on the government's books, but you'd think they might start to learn that their intrusions into the market ultimately result in a plethora of unintended consequences that they're remarkably ill-equipped to deal with.

Okay, so I hope it's as clear to you as it is to me that lithium is getting frothy. To accommodate the marketplace, the firm Global X Funds just launched a new ETF based on lithium - called the Global X Lithium ETF (NYSEARCA:LIT). This fund charges a 0.75% expense fee, which is what you'll pay the fund managers up front when you buy the fund, and you'll pay it again every year. Suffice to say, this fund contains 20 different companies that are primarily involved in "some aspect of the lithium industry such as lithium mining, exploration and lithium-ion battery production." (See fund's holdings here (pdf).) It's split just about right down the middle between battery makers and lithium miners.

So, how do you go about shorting it? If you're not already set up to short stocks with your brokerage, you'll have to do so. It's no more difficult than opening up the account in the first place. Then, I'd wait for this ETF to enter a downtrend, and on any uptick enter your buy-to-cover order.

LIT has been trading super-flat since it was launched, but I expect some momentum to build around this fund. After all, it's lithium - the wonder element. I'd look for an exit from the short at anything greater than a 30% dip after you've borrowed the shares. There's plenty of volume (about 50,000 units a day), so you should be able to get your order filled. As always, be patient, and stick to your principles.

Disclosure: No positions