Chance Carson on Commodity ETFs and ETNs

Chance Carson is founder and chief investment officer at Alpine Strategies in Colorado Springs, Colo. The firm uses exchange-traded funds, exchange-traded notes and closed-end funds in managing portfolios for high-net-worth investors.

On Friday, IndexUniverse.com Managing Editor Murray Coleman caught up with the veteran portfolio manager and analyst, who also runs an educational site at www.aboutetfs.com. Carson, who has been a money manager and analyst for more than 35 years, is currently designing portfolios with around 35% of Alpine's total client assets allocated to alternative investments.

HardAssetsInvestor (HAI): How is the government rescue plan for banks impacting commodities markets?

Chance Carson (Carson): The winding down of the banking sector crushed the commodities markets for about six weeks. But on Sept. 11, almost all of the commodities funds started to turn up. Many fell about 25-30% from the July peak until mid-September. Once the rescue package started to enter the scene, they shot up. Across the board, gold has led the surge. But agriculture and the diversified commodities baskets have dramatically bounced back as well.

HAI: Will that continue?

Carson: As soon as there's some solid plan in place for the government to rescue the U.S. economy, speculators will jump back into the market. Then, another shoe will fall and markets will resume their rally. We think this could go on for another six or seven years. This could be one of the best entry or reentry points for anyone wanting to diversify into commodities. We may not have reached the low point in this particular cycle, but we're pretty close.

HAI: What looks particularly attractive in that sense then?

Carson: Energy and alternative energy should take lead positions right now. We like ELEMENTS Rogers International Commodity ETN (RJI). It holds 36 different commodities with 45% in energy, 35% in agriculture and 20% in metals. So it's extremely well-diversified and covers the main bundles. For the best ETF, I'd suggest either PowerShares DB Commodity Index Tracking Fund (DBC) or iShares S&P GSCI Commodity-Indexed Trust (GSG). Those are funds with broad baskets. DBC is the largest and the oldest and most actively traded.

HAI: Are you using other ETFs or ETNs to drill down even more into commodities?

Carson: Yes; oil executive insiders are heavily purchasing their own shares. That's the largest repurchasing activity we've seen in any asset class currently. It's sending us a signal that energy and alternative energy is where the action is going to be in the next 20-25 years. It's estimated that in the next 20 years, demand for alternative energy will grow by 400%. But demand for oil and natural gas will increase around 40-70% in that same period. Most notably, the demand for coal is expected to rise by 72% in the next 20 years.

HAI: Do you think it's important to include traditional oil funds in a portfolio then?

Carson: I do. In our core stock portfolios, which is different from the alternatives sleeve, about 15% is in traditional oil and natural gas plays. That's out of a total of about 25% allocated in core stock funds. The BearLinx Alerian MLP Select ETN (BSR) is one of my favorite energy plays right now. It's a pool of energy infrastructure master limited partnerships. It's an assortment of infrastructure and pipeline plays that transport oil. It's yielding 7.2% currently.

With growing demand for oil and gas, moving those products around the world becomes very important. We've seen fairly stable earnings from these companies. But as oil prices have fallen, investors have thrown them into the same bucket and sold off shares. These companies have much different fundamentals, and in past cycles after big sell-offs, oil and gas infrastructure plays have often doubled or tripled while earning very robust dividends along the way.

HAI: In terms of specific alternative energy funds, what are your favorites?

Carson: I like coal a great deal. Nuclear is my least favorite. That's because the projected increase in demand for nuclear energy is going to be less than 2% per year for the next 20 years. I suspect the biggest problem facing nuclear is concern about the environment - people just don't want nuclear plants in their backyards. In terms of coal, there's one reasonably diversified, well-constructed ETF we like, the Market Vectors Coal ETF (KOL). The International Energy Agency feels that coal is going to have the second-greatest demand increase over the next 20 years.

HAI: What is the top growth leader expected to be?

Carson: The IEA is projecting that demand for renewable energy plays will increase by over 400% in the next 20 years. It dwarfs everything else. To capture that segment in alternatives, we're using the Market Vectors Global Alternative Energy ETF (GEX). Some 85% of that fund's portfolio is in solar, wind, geothermal and biofuels. And 68% of its assets are outside the U.S.; that's another great benefit. We expect the U.S. dollar to continue to decline, particularly after this government bailout is finalized. That will mean GEX can benefit on an exchange-rate basis as well. There are 14 different ETFs and ETNs in the alternative energy sector at this moment. GEX isn't the most popular, but it's probably the best pure alternative energy play on the market now.

Besides GEX and KOL for alternatives, we like the ELEMENTS Rogers International Commodity Agriculture ETN (RJA) and the PowerShares DB Agriculture ETF (DBA) for agriculture. Besides alternative energy, agriculture is my second-favorite part of the market. As developing nations move into middle-class consumption patterns, particularly in food, there could be food wars taking place going forward. Agriculture could be a bigger growth area than alternative energy, as a matter of fact.

HAI: Do you expect to see more expansion among ETFs and ETNs launching in the commodities space?

Carson: Absolutely, and the evidence is what's going on right now. Last year, only 29 commodities ETFs and ETNs existed. Today, there are 148 and counting. We break these down by asset class: In diversified commodities baskets, there are 19 different ETFs and ETNs; in oil and gas energy, there are 45; in alternative energy, there are 14; in metals and basic materials, there are 40; and in agriculture there are 30.