If you’ve been looking to add metals to your portfolio lately, you might be confounded by the variety of exchange-traded options that offer exposure to the market.
Let’s shine some light on this pocket of the investment market. There are many metals to choose from, but I’ll focus on copper to simplify the comparison of the advantages and disadvantages of each investment approach.
All of the following are viable exchange-traded products that offer exposure to the copper market, but they do it in different ways that result in significant exposure and return differences. So, it’s important to understand the various products in order to match your investment thesis with the right product.
There are three main ways to access copper in an exchange-traded product:equity ETFs, commodity ETFs and ETNs (exchange- traded notes). Actually, physical copper isn’t strictly available right now, but it looks likely that it will be soon, as I discuss below.
First, there are equity ETFs. These ETFs acquire shares of publicly traded companies that mine or refine copper.
The important thing to understand here is that you’re gaining exposure indirectly, with the company’s stock price correlated with the price of copper. Depending on the company and the diversity of its operations, that may be a little or a lot.
The fact that exposure in this case is indirect is not inherently bad or good, it’s just reality. Following are two simple cases for why this avenue of exposure could be good or bad.
Imagine a copper miner or refiner with a competitive advantage—well positioned in the market and the exclusive producer of a particular good. Such a firm may have serious pricing power that allows it to outperform the spot price of copper.
Alternatively, the company could have diverse operations of which copper is only a small portion. In this case, the company’s stock price is a poor proxy for the price of copper because its stock price is subject to many factors other than the price of copper.
CU is the better of the two fund, in my opinion, because it uses a tiered allocation scheme that weights companies by the percentage of revenue generated from copper production. In contrast, COPX sticks to a straight market-cap-weighting scheme.
Futures Or Physical
Commodity ETFs are another way to gain exposure to the price of copper.
A commodity copper ETF gains its exposure either by purchasing physical copper or by using futures contracts. There are advantages and disadvantages of both.
Buying, storing and selling a physical commodity is far more expensive than purchasing a futures contract from an exchange, so operational costs are likely to be high for physically backed ETFs.
On the other hand, futures contracts are subject to the effect of contango, which will likely reduce realized yield. Contango refers to new contracts being more expensive than expiring ones, which hurts returns—sometimes by a lot over the longer term—as fund managers maintain exposure.
Currently, the United States Copper Index Fund (CPER) is the only option in this category. It uses futures contracts to gain its exposure, which means it is subject to the deleterious effects of contango, or negative roll yield. It does, however, “optimize” those contracts to mitigate those effects.
Two years after filing, the Securities and Exchange Commission recently granted J.P. Morgan permission to market a physically backed copper ETF. However, the SEC recently postponed its decision to allow iShares to market a very similar product, so it’s not yet clear if any physical copper funds will be brought to market soon.
Still, it seems likely, at which point we will finally see if investors are interested in such products.
The final way to gain exposure to the price of copper is through an ETN. ETNs are senior debt notes issued by large banks so, in contrast with ETFs, exchange-traded notes are subject to counterparty risk.
The bank promises to pay the returns of the index minus a management fee, which means there’s no tracking fee. But you’ll need to pay particular attention to who your counterparty is and what index they use.
Both ETNs provide the returns (minus fees) of indexes that track the performance of futures contracts. JJC uses front-month contracts, whereas CUPM optimizes its contracts in an attempt to mitigate the effects of contango.
Ultimately, a broad collection of exchange-traded products offer exposure to the metals market. Each product has a different approach and offers different exposure.
As always, it’s crucial to choose the product that aligns best with your investment goals.
At the time this article was written, the author held no positions in the securities mentioned. Contact Spencer Bogart at email@example.com .
Permalink | ' Copyright 2013 IndexUniverse LLC. All rights reserved