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Can Commodity ETFs Break a Five-Year Jinx?

Zacks Equity Research

With 2016 drawing to a close, global investors’ community is now eyeing the commodity sector. After a gap of five straight years, the commodity sector is ushering the hope that it will likely to scale higher for the first time this year. Although the benchmark Bloomberg Commodity Index (BCOM) was down 0.5% in October, it rallied 9% year-over-year in the first nine months of 2016.

In contrast, in the last five years, the commodity sector witnessed investment withdrawals averaged almost $14 billion in the last quarter resulting in an average 8% drop in BCOM. However, in the first three quarters of 2016, this sector raked in a massive $62.3 billion in investments. Commodities are enjoying a broad advance and are on track to break a five-year streak of annual losses.

Agriculture: Key Growth Driver

The U.S. agricultural sector witnessed a bumper harvest this year. Grains posted a monthly gain of almost 5% in October. This was attributed to two factors — the large bearish bets by speculative investors and the substantial demand for grains and oilseeds, according to Mike McGlone, senior analyst at Bloomberg Indices. According to recent data released by the US Department of Agriculture, US export sales of corn are up 97% from the previous crop year, sales of soyabeans have risen 35% while wheat sales are 26% higher. Soyabean export has led economic growth in the third quarter of 2016 as well.

US Dollar Price Easing

One important reason to invest in commodities is inflation hedge. Inflation is a never ending process and is likely to increase in the future. One can counter it by buying commodity futures. The US dollar witnessed a bull run in the 2011-2015 period. Since most commodities are priced in dollars, they are also pretty expensive. However, the dollar price has eased relatively in 2016, courtesy of FED’s reluctance to tighten monetary policies. Recovering macro fundamentals, tight supply conditions and rising global demand along with a delay in rate hike boosted prices of a wide range of commodities including oil, sugar, gold,zinc and soyabeans. (read: Commodities Enter Bull Market: 6 ETF Winners).

India: Seeing Rising Commodity Demand

India becomes a major importer of commodities which helped the global commodity export make up for losses after owing to volatility in the Chinese economy. India's demand for crude oil, is currently growing at a much faster pace than in China. Moreover, demand for a wide range of commodities in India, including palm oil, sugar, rubber and natural gas, is rising at a significant rate.

The World Bank believes India will continue to grow at a brisk pace of 7.6% in 2016 and 7.7% in 2017 while IMF projects the economy to grow 7.6% for both fiscal 2016–17 and 2017–18. The World Economic Situation and Prospect report, in its mid-2016 update, stated that India is expected to achieve 7.5% GDP growth in 2017 and the economic prospect of the South Asian region will be contingent on the growth trajectory of India and Iran. Notably, India’s economy currently accounts for nearly 70% of South Asia’s GDP. (read: Can India Small Cap ETFs Continue Their Bull Run?)

Uncertainties of Late

Despite the rosy scenario, the commodity sector’s performance in the last two months of 2016 will depend to a large extent on the result of the US Presidential election and a crucial OPEC meeting to be held at the end of this month. According to the American Farm Bureau Federation, both Donald Trump and Hillary Clinton oppose the Trans-Pacific Partnership, a proposed trade deal that would end barriers for US agricultural commodities including beef, pork, soyabeans and cotton. Infact, Trump has proposed punitive tariffs on China and Mexico, the top-ranked foreign markets for US soyabeans and corn export.

On the other hand,  Trump victory may boost gold prices since investors likely to opt for safe investments in the face of uncertainty over policies. Further, the outcome of the OPEC meeting will have a major bearing on the commodities market since energy is the largest commodity segment by value.

ETFs in Focus

Below we highlight a few commodity ETFs which we believe will perform reasonably well in the days ahead:

PowerShares DB Commodity Index tracking Fund (DBC): This fund is based on the DBIQ Optimum Yield Diversified Commodity Index Excess Return & managed by DB Commodity Services LLC. The Index is a rules-based index composed of futures contracts on 14 of the most heavily-traded & important physical commodities in the world. It manages an asset size of nearly $2,361.6 million and an average daily trading volume of 2,215,809 shares. The fund charges an expense ratio of 93 basis points (bps) a year. DBC has gained 10.48% so far this year (as of November 7).

PowerShares DB Optimum Yield Diversified Commodity Strategy Portfolio ETF (PDBC): The ETF is an actively managed exchange-traded fund that seeks to achieve its investment objective by investing in commodity-linked futures and other financial instruments that provide economic exposure to a diverse group of the most heavily traded commodities of the world. The fund manages assets worth $474 million and an average daily trading volume of 268,087 shares. The fund charges an expense ratio of 59 bps a year. PDBC has rallied 10.25% so far in 2016 (as of November 7).

WisdomTree Continuous Commodity Index Fund (GCC): This fund is providing an innovative and efficient way to deliver broad based, diversified commodity exposure. It aims to achieve this by using futures contracts to track the Thomson Reuters Equal Weight Continuous Commodity Total Return Index. The CCI-TR is an equal weighted index of 17 commodities plus an additional Treasury bill yield.  It manages an asset size valued $213.8 million and an average daily trading volume of 46,710 shares. The fund charges an expense ratio of 85 bps a year. GCC is up 5.18% so far this year (as of November 7).

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PWRSH-DB COMDTY (DBC): ETF Research Reports
PWRSH-DB OYDCSP (PDBC): ETF Research Reports
WISDM-CONT CMD (GCC): ETF Research Reports
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