Long-Only Commodity ETFs vs Futures- April 2013

We’ve made no secret that we think Commodity ETFs are a poor choice for investors (see Commodity ETFs Suck – 2012 Edition), and the underperformance of those ETFs compared to futures contracts in 2011 and 2012 bore that out. But so far, 2013 has not matched our expectations, with commodity ETFs ahead of the Dec futures performance through the end of April.

This month the ETF advantage shrank a bit for crude oil and corn, but expanded for natural gas. UNG has had a great year, returning more than 24% since the beginning of the year (Disclaimer: past performance is not necessarily indicative of future results). But that’s just one year since it was declared the worst ETF investment of all time after it had lost more than 96% since inception. The ETF is now outperforming the rallying market it aims to track, leaving us to admit that even a blind squirrel finds the nut sometimes.

Do we think the commodity ETFs will continue to outperform a simple strategy of buying and rolling the December contract annually?  No.  Maybe they outperform for a month, a quarter, or even a year at some point (and this could very well be one of those years). But they will still be rolling their positions many times more than a single annual roll, creating a drag in the form of cost and the roll yield.

Stay tuned.

Disclaimer: Past performance is not necessarily indicative of future results.

 

Long-Only Commodity ETFs vs Futures- March 2013

We’ve made no secret that we think Commodity ETFs are a poor choice for investors (see Commodity ETFs Suck – 2012 Edition), but we may have to revisit our premise with commodity ETFs ahead of the Dec futures performance through the end of March.

Are they getting more sophisticated in how they approach the markets? The short answer is yes – for example, some are now spreading their positions across multiple contract months in the hopes of improving performance. In addition, we’ve noted before that short-term changes in supply can give ETFs the advantage, which they’ve definitely seen in the first few months of this year.

Do we think the commodity ETFs will continue to outperform a simple strategy of buying the December contract and rolling it annually?  No.  Maybe they outperform for a month, a quarter, or even a year at some point. But they will still be rolling their positions many times more than a single annual roll, creating a drag in the form of cost and the roll yield.

Stay tuned.

Disclaimer: past performance is not necessarily indicative of future results.

What about Peak Oil Demand?

The natural gas revolution has been busily disrupting energy markets (and also transforming North Dakota’s economy and lighting up the state so much it’s actually visible from space). Now, a report from Citigroup analysts predicts that the rapidly expanding natural gas industry will upend a long-running prediction about the future of oil. Bloomberg reports:

“The shift from oil to gas is already under way in the U.S.,” Seth Kleinman, the head of European energy research at Citigroup, and five other analysts wrote yesterday in a report. Other countries are poised to follow suit, they wrote, as gas becomes more plentiful and anti-pollution efforts intensify…

“Oil demand growth may be topping out sooner than the market expects,” Kleinman, based in London, and his colleagues wrote. Greater fuel economy may combine with the shift toward gas to cause global demand to level off at about 91 million barrels a day, the report said.

In other words, we may never hit the doomsday scenario described by the “peak oil” theory. The idea of “peak oil” really took off in the 1960s, and it’s about as intuitive as it is controversial: it claims that because the world’s oil supply is finite, we’re bound to reach a point where oil production hits a peak and begins declining. That, in turn would lead to soaring oil prices, collapsing economies, and a generally chaotic future.

Many believers in the theory thought that we would hit that peak decades ago. Fortunately for us, technological advanced have steadily improved our ability to access more and more difficult-to-reach oil, staving off the arrival of that day when we can no longer extract enough oil to meet global demand.

Now, the steady march of technology has unlocked vast quantities of an alternative fuel source, and if the Citigroup report proves accurate, we may soon see a scenario that peak oil believers never would have expected: hitting peak oil demand before we reach peak oil supply. Right now, oil is about 4 times as expensive per BTU as natural gas. But, if plentiful natural gas can take the place of oil for more purposes, we would likely see the cost per BTU of both to come closer to parity. In other words, a significant decline in oil prices and a corresponding increase in natural gas prices.

Of course, there are still many uncertainties that could prevent Citigroup’s crystal ball gazing from coming true. But the natural gas boom is certainly changing the energy market in ways that few could have predicted just a few years ago.

Natural Gas on the Cusp

Natural gas futures have proven even more buoyant than the stock market in the last few weeks – with the price of contracts for April delivery having risen nearly 18% in less than a month – and we’re looking at the near term intra-day high of $4.06 set back in November to see if the commodity can set a new 17-month high, reaching a level not seen since September of 2011.

Chart courtesy Finviz.com. Disclaimer: past performance is not necessarily indicative of future results.

But panning back out and looking at the big picture – despite the move back up from the lows in 2012, Natural Gas has remained stuck in a trading range of between $2 and $6 for going on 5 years now. We’re not in the business of long-term prognostication on markets, but we have a strange curiosity for what Natural Gas is doing (probably from our battle wounds around mid-08 when it shot up to $14) – and there are several potential developments that could send the market soaring or plunging:

  • The issue of idle capacity is one we’ve heard several times. The idea is that plenty of companies are sitting on leases with natural gas potential, but haven’t started drilling because of how low prices have been. According to the Congressional Research Service, there are 20.8 million acres leased for oil and gas that are currently not in production or exploration. As prices rise, those areas could begin production, scaling up supply in line with demand to keep prices low.
  • International trade could become a major player – the US exports some natural gas, but such activity is currently limited by a lack of capacity. But there’s a robust debate over whether the US should start ramping up efforts to export Liquefied Natural Gas (LNG). If US gas starts making its way to international markets in larger volume, the increased demand could put upward pressure on prices.
  • And of course, there’s the outside chance of a ban on hydraulic fracturing (fracking), the drilling technique that led to the boom in the first place. It may seem unlikely, but several states – including New York – have already implemented moratoriums on the drilling practice. California is currently considering its own stance on the practice. A nationwide ban still looks very unlikely at this point, but even piecemeal efforts to stymie the practice could place limits on natural gas output.

Fortunately, with CTAs we’re not in the business of predicting the future – only responding to it. No matter which of the above scenarios comes to pass, we’re really just hoping for more sustained trends like this one.

See Also:

Four Years Later: Recovery Complete?

The Future of Natural Gas

Long-Only Commodity ETFs vs Futures- February 2013

February is finished, which means we have a new month of data in our regular series examining long-only commodity ETFs, and comparing their performance to the December-dated futures contracts. You’ll notice that this time around, two of the ETFs seem to have the advantage. What’s going on? Well, this is something we’ve run into before, and there are a couple of factors at work.

Much of the ETF underperformance we observe is generated by one glaring inefficiency – they have to roll their front-dated futures contracts repeatedly throughout the year. At the beginning of the year, before the ETFs have had to start rolling their contracts, it’s possible for them to start out slightly ahead. The second factor (which we also saw last year) is when near-term concerns, such as expectations of tighter supply, cause a price increase in short-dated months, but have a minor effect on longer-dated months. In either case, we expect that the futures contracts will eventually overtake the ETFs – and we’ve been proven right twice before.

The commodity ETFs may be sitting pretty right now, but they should enjoy it while it lasts. We doubt they’ll be celebrating for long.

Disclaimer: past performance is not necessarily indicative of future results.

Long-Only Commodity ETFs vs Futures- January 2013

January is finished, which means we have a new month of data in our regular series examining long-only commodity ETFs, and comparing their performance to the December-dated futures contracts. You’ll notice that this time around, two of the ETFs seem to have the advantage. What’s going on? Well, this is something we’ve run into before, and there are a couple of factors at work.

Much of the ETF underperformance we observe is generated by one glaring inefficiency – they have to roll their front-dated futures contracts repeatedly throughout the year. At the beginning of the year, before the ETFs have had to start rolling their contracts, it’s possible for them to start out slightly ahead. The second factor (which we also saw last year) is when near-term concerns, such as expectations of tighter supply, cause a price increase in short-dated months, but have a minor effect on longer-dated months. In either case, we expect that the futures contracts will eventually overtake the ETFs – and we’ve been proven right twice before.

The commodity ETFs may be sitting pretty right now, but they should enjoy it while it lasts. We doubt they’ll be celebrating for long.

Disclaimer: past performance is not necessarily indicative of future results.

Commodity ETFs Upping Their Game?

We keep regular tabs on a handful of long-only commodity ETFs (UNG, USO, and CORN), specifically how much these funds underperform the futures contracts for the same underlying commodity. We believe that managed futures, which can go long or short depending on market conditions, is a better investment strategy. But if you’re going to go long commodities, ETFs are not a particularly efficient means of doing so – and the data continues to bear that out.

But now it looks like we may need to broaden our look at commodity ETFs, as some new challengers have appeared that, at least on paper, claim they will be able to avoid the lackluster performance that has plagued their peers. MSN Money reports:

Take the UBS E-TRACS DJ UBS Commodity Index 2-4-6 Blended Futures ETN (BLND), which only has around $10 million in assets. The exchange-traded note tries to navigate a problem called contango — which occurs when current future prices are lower than contracts reflecting what prices could be a year from now — by buying futures contracts out in various months and “blending” them to create the index.

ETFs based only on current prices lose money if a market is in contango because they have to buy the higher-priced, longer-dated contract and sell the cheaper spot month. So they are selling low and buying high. The United States Natural Gas Fund (UNG) has consistently been a loser for investors because of issues of contango.

Will this prove more efficient than the traditional approach? Tough to say… they’re still not entirely eliminating the problems with frequent rolls (which is why we advocate that long-only investors roll just one time per year), and they could have a marketing problem with the ETF not matching the performance of the index it tracks in the short term. Will investors be willing to not make what the index makes on any single day/month/quarter in order to more closely track what the index makes in a year? That requires some advanced investing logic and willingness to seek long term results over short term gratification – something the average investor isn’t exactly known for.

For our part, BLND contains a basket of commodities, which makes it more difficult to compare against the underlying futures contracts. Nevertheless, it’s nice to see someone else acknowledging the problems dragging down many of the commodity ETFs out there.

Unfortunately, the rest of the article goes off the rails, arguing that commodity investors should “keep it simple” by investing in ETFs that track the producers the commodities – mining companies, agriculture companies, oil companies… and we can only shake our heads.

Sorry, but buying Exxon is NOT the same thing as being long crude oil. And we’re far from the only ones to criticize the idea of using mining companies to gain exposure to the metal markets. With the proliferation of ETFs tracking various combinations of companies and resources, it sounds like the ETF universe is trying hard to produce a better offering. We’ll be waiting for the data to provide a verdict, but until then, we remain unconvinced.