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More Pain in Copper ETFs?

Zacks Equity Research

The commodity ETF space has seen only a few winners so far this year, thanks to a strong dollar and weak demand (read: 3 Commodity ETFs Still Going Higher). Some products in the energy or soft commodities space (like natural gas, cotton or cocoa) have added double digits but others have seen significant weakness in the year-to-date period.

ETF investors have especially seen weakness in the industrial metals segment of the industry. These products have been crushed by sluggish conditions in some key emerging markets like China, recent fears of a deepening euro zone crisis as well as worries over continued dollar strength. These recessionary threats have kept industrial metals under pressure and have deeply hurt one metal in particular – copper – this year.

Copper prices have plunged by high single digits in the year-to-date time frame and are easily underperforming the broad markets and other industrial metals (read: Time to Sell This Commodity ETF?). High levels of inventories haven’t helped the situation either, especially considering the rapidly depreciating demand picture.

The decline in copper prices was also due to the global sell-off in gold and other commodities, weak Chinese GDP data, and lower global growth projections by the IMF. Furthermore, the currency issue has been especially bad this year as the U.S. dollar has appreciated significantly, reversing a long trend in the space. In fact, not only has the dollar been strong, it has actually been surging against a wide range of other global currencies.

And given the uncertainty surrounding the euro with all the Cyprus issues and ECB uncertainty, the dollar could continue to gain. This may be especially true if investors add in the threat of a triple dip recession in the UK, and a focused effort by Japan to weaken its currency against the greenback (read: Will the Dollar Strength Hurt Q1 Earnings?).

Amid these weak fundamentals, copper ETFs are facing tough times. In view of these circumstances, we do not think that the copper price and ETFs will see any revival in investor interest anytime soon.

Currently, there are three choices available in this poorly performing space. Instead of staying invested in these ETFs, investors should probably avoid or pair them with another commodity ETF that has a better outlook in a pairs trade:

iPath Dow Jones-UBS Copper Subindex Total Return ETN (JJC)

Launched in October of 2007, the ETN tracks the Dow Jones-UBS Copper Subindex Total Return. The index delivers returns through an unleveraged investment in the futures contracts on copper. The index currently consists of one futures contract on the commodity of copper (currently the Copper High Grade futures contract traded on the COMEX).

The product is a bit expensive as it charges 75 bps in fees per year. It trades in moderate volumes of 68,000 shares on average daily basis that increases the trading cost in the form of a somewhat wide bid/ask spread. The fund is also unpopular and has attracted $99.8 million of assets so far in the year. The fund lost over 15% of its value so far in 2013 (also read Copper ETFs Back on Track?).

JJC currently has a Zacks ETF Rank of 5 or ‘Strong Sell’ implying that there is significant bearishness facing the ETN in the months ahead.

iPath Pure Beta Copper ETN (CUPM)

Launched in April 2011, this ETN seeks to match the performance of the Barclays Copper Pure Beta Total Return Index. Unlike many commodity indexes though, this one can roll into one of a number of futures contracts with varying expiration dates, as selected using the Barclays Pure Beta Series 2 Methodology.

This approach still offers exposure to copper, but it might result in less contango. This can be an important factor, as shifting from month to month in contracts can eat away at returns during an unfavorable market situation.

However, investors should note that CUPM is illiquid with a paltry volume of about 1,000 shares a day, suggesting a wide bid/ask spread. As such, investors have to pay extra beyond the annual fee of 75 bps in fees per year (read: Trade Goldman's Commodity Picks with These ETFs).

This ETN also has a Zacks ETF Rank of 5 or ‘Strong Sell’.

United States Copper Index Fund (CPER)

This fund provides a vehicle to take directional positions on copper prices. It tracks the changes in percentage terms of its units’ net asset value to reflect the daily changes in percentage terms of the SummerHaven Copper Index Total Return, less CPER's expenses.

The index comprises either two or three eligible copper futures contracts that are selected on a monthly basis based on quantitative formulas relating to the prices of the eligible copper futures contracts developed by SummerHaven Indexing.

The portfolio consists of copper futures contracts and may include forwards and swap contracts. The ETF charges little lower than 65 bps in annual fees, but has amassed $2.1 million in AUM (see more in the Zacks ETF Center).

Additionally, it has a wide bid/ask spread, which increases the total cost for this fund thanks to its illiquid nature. The fund is down 14% year-to-date and has a Zacks ETF Rank of #5 or ‘Strong Sell’, suggesting that the product is also expected to continue its bearish run over a one-year period.

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Read the analyst report on JJC

Read the analyst report on CUPM

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