Exchange-traded funds offering exposure to Commodity Producers Equities have become a popular tool for those looking to make an indirect play on natural resource prices. These funds offer investors the ability to easily tap into the lucrative commodities market through a diversified basket of companies, while still reaping the cost efficiency benefits associated with the exchange-traded product structure. Investors who wish to access the mining sector have a number of options available at their fingertips; and while these products may appear similar, a closer look under the hood reveals some noteworthy differences [see also Does GLD Really Hold Gold, Or is it a Scam?].
The broad-based mining ETFs are impacted by a variety of factors, many of which are the same as those for the commodities themselves. Below we highlight some of the important factors to consider before investing in a mining ETF:
- Commodities vs. Stocks: Companies engaged in the extraction and production of natural resources tend to be more volatile than commodity spot prices themselves; this is because the profitability of producers is affected by the market price for the underlying resources. Investors need to understand that the performance of mining stocks may not always be correlated with the metals spot price itself. There is a rather simple explanation for this infamous phenomenon; most commodity producers hedge their exposure in the futures market, so that they can lock-in prices for their products far in advance to avoid volatility in their operating cash flows.
- Economic Cycle: During periods of economic expansion, strength in the manufacturing sector can lead to increased demand for many metals utilized in industrial processes. During slowdowns, however, mines often cut shifts and slow activity to avoid swelling inventories, potentially leading to excess supplies. Simply put, investors should be aware that the mining sector is cyclical [see also Futures Free Commodity ETFdb Portfolio].
- Emerging Markets: As populations across Latin America and Asia continue to swell, demand for goods like automobiles, electronics, and jewelry is expected to continue climbing, further bolstering demand for industrial and precious metals alike. Mining companies stand to benefit as urbanization levels in emerging markets continue to increase and demand for industrial and consumer goods grows. Likewise, a slowdown in economic growth overseas could paint a gloomier outlook for commodity producers.
Below we offer an under-the-hood look at the broad-based mining ETFs, highlighting noteworthy pros and cons for each:
SPDR S&P Metals & Mining ETF (XME)
This is the oldest and most popular broad-based mining fund; XME has accumulated close to $772 million in assets under management since launching in mid-2006. This ETF holds 43 U.S. companies and is well diversified across all corners of the mining industry; top allocations are made to steel and diversified metals & mining companies. Investors should also note that this ETF features exposure to coal & consumable fuels producers, resulting in less of a "pure play" exposure to the mining industry. Allocations to precious metals and aluminum producers is also included [see also Natural Gas and Company In Steep Contango].
Although it doesn't feature the deepest basket of holdings, this ETF does boast the least top-heavy portfolio; only about one-third of total assets are allocated to the top-ten holdings. XME is also the most cost effective broad-based mining ETF, charging 0.35% in expense fees.
EGShares Emerging Markets Metals & Mining ETF (EMT)
This ETF allows investors to tap into the lucrative emerging markets asset class while maintaining a focus on the mining industry. EMT holds 25 of the largest publicly-traded mining companies involved in industrial and precious metals exploration, extraction and production within the emerging world. Top holdings by country include: South Africa, China, Brazil, and Russia. EMT also makes allocations to companies in Mexico, Indonesia, Poland, and India [see also Three Things Wall Street Journal Didn't Tell You About Commodities].
EMT's portfolio is a bit top-heavy, seeing as how it allocates about two-thirds of total assets to the top-ten holdings; this may increase the company-specific risk associated with this product. This is also the most expensive ETF from the list, charging 0.85% in expense fees given its targeted international exposure. Despite these drawbacks, this ETF may appeal to investors as it is currently the only emerging markets mining ETF available.
iShares MSCI Global Select Metals & Mining Producers Fund (PICK)
This is the newest offering to join the space and PICK offers plenty to be excited about. This ETF launched at the end of January 2012 and it distinguishes itself from the other two mining ETFs through its impressive portfolio; PICK holds a basket of 311 components spreading across both developed and emerging markets. Exposure is tilted towards diversified metals & mining companies, although steel companies also account for a significant chunk of the portfolio. Allocations to precious metals and aluminium producers is also included. Top holdings by country include the United Kingdom, Australia, the U.S., Brazil, and Japan [see also iShares Rolls Out Commodity-Focused Equity ETFs].
One potential drawback of PICK is the fairly low trading volumes; this ETF is likely less-than-ideal for traders looking to make a short-term play on the mining industry. Aside from its infancy, this ETF offers an incredibly deep portfolio of international holdings for just four more basis points than rival XME.
Disclosure: No positions at time of writing.
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