Is Commodity ETF Slicing and Dicing Necessary?

by: Richard Kang

If there’s an area where commentary has exceeded that which is required, it has to be in the commodity complex. For every Jim Rogers on the bullish side there is more than likely an equally vocal counterpart on the other side. True to expectations, with such a hot sector, we have seen a decent share of commodity related ETFs, with certainly more than enough in the energy subsector.

Broad based commodity index ETFs [PowerShares DB Commodity Index TrackingFund (NYSE:DBC) and iShares GSCI Commodity-Indexed Trust (NYSEARCA:GSG)] have allowed for a one-stop shotgun approach but now Deutsche Bank (NYSE:DB) and PowerShares have sliced and diced yet another sector (follow the Deutsche Bank link) but, to me, this development does deserve merit.

What investors now have is the ability to fine tune their required commodity allocation instead of letting DBC and GSG do it. The new funds are:

  • PowerShares DB Agriculture Fund (NYSEARCA:DBA)
  • PowerShares DB Base Metals Fund (NYSEARCA:DBB)
  • PowerShares DB Energy Fund (NYSE:DBE)
  • PowerShares DB Oil Fund (NYSEARCA:DBO)
  • PowerShares DB Precious Metals Fund (NYSEARCA:DBP)
  • PowerShares DB Silver Fund (NYSE:DBS)
  • PowerShares DB Gold Fund (NYSE:DGL)
  • Is this slicing and dicing really required?

    According to the factsheet for DBC on the DB Funds website, this is its breakdown:

  • 35% light sweet crude
  • 20% heating oil
  • 12.5% aluminum
  • 11.25% corn
  • 11.25% wheat
  • 10% gold
  • According to the iShares website, GSG, which tracks the GSCI Total Return Index, has a breakdown of:

  • 71% energy
  • 11% industrial metals
  • 11% agriculture
  • 5% livestock
  • 2% precious metals
  • The DBC factsheet also gives some information that should be of no surprise to the commodity index investor. The performance table shows 1 year returns as of September 30, 2006 of 9.32% for the DB Commodity Index, -21.14% for the GSCI and -6.11% for the DJ-AIG Commodity Index. This type of wide discrepancy is commonly found when comparing various hedge fund indices but not your more traditional indices. The problem is in the composition. I would strongly suggest that investors in this space read this feature article from written by Matt Hougan titled “Choose Your Commodity Index Wisely". (The site requires membership which is free.) You’ll note that Matt’s article was written in May 2005 and the index breakdowns differ slightly from the data above but they’re not far off. Take special notice to the table at the end of his article that gives a nice comparison of the various indices and their breakdowns. Unfortunately, the DB Commodity Index was not one of the indices included in his analysis.

    There’s not a lot of trading history, so here’s the six month chart showing DBC and GSG:


    The general trends are similar but the gap is significant starting in early September when the lines diverge.

    Bottom line is that there’s little surprise that the GSCI had by far the worst performance of the three cited commodity indices due to its roughly three-quarters exposure to energy.

    Although I’m not as big an oil bull as I was one year or two years ago, longer term I’m still a bull. Recent news has suggested that the environment is as high a priority as any other to the average citizen. How will this play out in the energy/alternative energy space is a whole other blog entry. Whatever my call (or your call is), for sizeable portfolios and for sophisticated investors, DBC or GSG just can’t provide the precision required for adequate portfolio management. The commodity complex is just too broad a space to be managed with just a DBC or GSG position … aside for the very small sized portfolio.

    Clearly, the new PowerShares ETFs overlap considerably with existing ETFs. Still, we’re seeing what I believe to be the first exposure into the agricultural space. The base metals ETF allows for exposure to aluminum, zinc and copper which have gained considerable online chatter over the past few years. The energy ETF is similar to USO and provides for a more diversified instrument compared to its counterpart, DBO.

    To those that argue that the ETF market has, and continues to, “slice and dice” … I say their argument is strong for certain areas like the US equity market. In the case of the commodity complex, what Deutsche Bank and Powershares have brought to market is ideal.