Comparing Base Metals ETFs

Recent news of more commodity ETFs (actually ETCs trading out of Paris) makes me wonder about some of the truly “high flying” sectors within the commodity complex. For example, here are some recent press releases related to steel:

AMEX STEEL INDEX UP 9.08% IN JANUARY

NEW YORK, February 5, 2007 – The Amex Steel Index [STEEL] rose 9.08 percent in January.* STEEL is a modified market capitalization-weighted index comprised of the common stocks or ADRs of publicly traded companies involved primarily in activities related to steel production. As of January 31, 2006, STEEL included 37 securities. STEEL is rebalanced quarterly. The next rebalancing will occur on March 16, 2007. The Market Vectors – Steel ETF (Amex: SLX) is an exchange-traded fund that seeks to replicate, as closely as possible, before fees and expenses, the price and yield performance of STEEL. SLX generally holds all of the securities that comprise STEEL in proportion to their weighting in STEEL. Options on SLX are listed on the Amex.

AMEX STEEL INDEX UP 40.70% IN 2006

NEW YORK, January 4, 2007 – The Amex Steel Index [STEEL] rose 0.77 percent in December and gained 40.70 percent for the year ending December 31, 2006.* STEEL is a modified market capitalization-weighted index comprised of the common stocks or ADRs of publicly traded companies involved primarily in activities related to steel production. As of December 31, 2006, STEEL included 38 securities. STEEL is rebalanced quarterly. The next rebalancing will occur on March 16, 2006.

The Market Vectors – Steel ETF (Amex: SLX) is an exchange-traded fund that seeks to replicate, as closely as possible, before fees and expenses, the price and yield performance of STEEL. SLX generally holds all of the securities that comprise STEEL in proportion to their weighting in STEEL. Options on SLX are listed on the Amex.

Here’s the chart since SLX’s inception:

Up about 22% over about a three and a half month period. How does this compare with some other related ETFs?

We see from this second chart how the Steel index moves in a fairly close pattern with the Vanguard Materials ETF (VAW), iShares Dow Jones US Basic Materials (IYM) and SPDRs Metals & Mining (XME). I’m surprised that SLX, being less diversified than the other ETFs mentioned here, has not shown more overall volatility over this period although it has shown greater strength in the run up over the past month.

PowerShares DB Base Metals Fund

But the real question is what’s going on with the PowerShares DB Base Metals Fund (DBB)? Based on the above chart, it’s the odd guy out. According to the fund’s site:

Description

The PowerShares DB Base Metals Fund is based on the Deutsche Bank Liquid Commodity Index – Optimum Yield Industrial Metals Excess Return™ and managed by DB Commodity Services LLC. The Index is a rules-based index composed of futures contracts on some of the most liquid and widely used base metals – aluminum, zinc and copper (grade A). The index is intended to reflect the performance of the industrial metals sector.

No mention of steel here, just aluminum, zinc and copper. More specifically, according to the fund’s fact sheet the underlying index is reset to have equal weighting to the three metals “annually during the first week or so of November. Throughout the year, the precise weight of each commodity in the Index will change based on price changes." The current weights are updated each day. A quick scan of that link shows currently an approximate 41% weight in aluminum, 29% weight in zinc and 30% weight in copper.

Further to my blog entry yesterday about the commodities ETF launch by ETF Securities, I refer to some of their funds to see how these specific metals have done recently. A London Stock Exchange site provides a chart for an ETF linked to Aluminum from ETF Securities. They provide a chart for the zinc ETF and the copper ETF. So while most of the lines have been going up in the 2nd chart above, clearly DBB has been moving in the opposite direction due to significant weakness in zinc and copper prices.

Update on my entry from yesterday: As discussed, the new offerings (they’re termed ETCs) from ETF Securities will be launched on Euronext Paris, but they are already listed on Euronext Amsterdam, Deutsche Börse and the London Stock Exchange. For U.S. investors, the LSE is particularly interesting as the ETCs are USD-denominated on that exchange.

Here’s some information on the other ETFs mentioned above:

Vanguard Materials ETF

From the Vanguard ETF site specific to VAW (click to enlarge):

VAW seems quite well diversified (like IYM, it’s a broad materials fund as opposed to the others), including an 11.3% allocation to steel, all with a cost of 25bps … not bad at all. However, as a general materials fund, there’s significant chemical exposure.

iShares Dow Jones US Basic Materials

Information on the iShares Dow Jones US Basic Materials (IYM) can be found on the iShares site. Also note that BGI also has a global ETF called the iShares S&P Global Materials Index Fund (MXI). Like VAW, IYM has its biggest exposures (roughly 53%) in chemicals. Just over 12% of the fund is allocated to steel. No surprise then from my 2nd chart that VAM and IYM track very closely.

MXI only has a track record going back to September 12th of last year but as you can see, as a global version of IYM, it also tracks it closely (3-month chart):

SPDRs Metals & Mining (XME)

This ETF from SSGA is more focused than those from Vanguard and iShares. According to the fund’s site, and in particular it’s holdings list, there’s a lot of exposure to steel. So, here’s the chart comparing XME and SLX:

Fairly close, as expected.

So, what does this all mean? There are a lot of products that appear to be covering the same space. But in fact, the overlap is not as great as one might think. If you want exposure to steel in its purest form, it’s got to be SLX -- though you’re getting exposure to an index of companies in the steel industry. For exposure to other industrial base metals (though in this case the exposure is directly to certain commodities markets), there is the PowerShares DB Base Metals Fund (DBB) as well as a similar fund from ETF Securities. For even broader exposure, and back to a basket of underlying stocks, there’s XME, IYM, MXI and VAW.

So despite a significant push of new offerings in the commodity space, and in this case specific to base metals, we can see that investors now have the opportunity to more adequately fine tune their exposures and be more precise with their opportunistic calls.

I see an opportunity here also for infrastructure and alternative energy (especially wind farm) fund managers to use an instrument related to steel for hedging purposes, although considering size, they may already be implementing hedges through the futures markets. Certain manufacturers in the computer hardware sector may be more interested in something like DBB. One can go on and on with examples of how certain investors would want (or need) instruments specific to a certain commodity.

Whether the relevant ETF instrument is redundant considering the availability of its counterpart in the futures market is an interesting thought -- it all depends on the type of users that are out there and the demand from each segment.

Comments

[RogerNusbaum]

great article

[Richard Kang]

Thanks Roger

[d_teller]

About 2 mos. ago, I went to the site that listed the ETC's for info ...but it was clearly stated that they were not available to U.S. purchasers. They really appealed to me because they are not highly correlated to the US ETF's that have commodity futures, and they weren't the shares of the companies that produce/market commodities, but rather small sectors of e.g., basic metals, grains, etc., which may be underweighted in the Energy heavy GSCI. They didn't have an active or rotational or contango etc. cost built in. I'd rather buy corn & aluminum than 50% oil. I don't fancy myself a futures/options trader glued to my PDA/Blackberry. Maybe with the NYSE beginning to broaden its reach, the SEC will approve these ETC's (vis-avis ETN's) for U.S. purchasers. One can hope. Thanks for the head's up.

[Richard Kang]

DT: Click above on "More articles by Richard Kang" and you'll find my email address. Send me an email and I can reply back with the contact name/info for a leading market maker in Europe for these products and will likely be able to help you.