There’s a reason why so many investors get their fingers burned playing with commodities. Every commodity is different, every commodity has unique trading peculiarities and almost every commodity favours investors who can, when necessary, take delivery of the commodities in question.
All of which does not favour your traditional buy and hold investor.
Making the point over at Index Universe is Dave Nadig.
His insightful piece looks at the component returns of the S&P GSCI commodity in the S&P’s quarterly review of the index:
As the former Barclays Global Investors ETF structurer concludes:
This chart shows in stark, stark detail the craziness that is being a commodities investor.
To explain, Nadig says you have to think of the light blue line as the reflection of the cost or benefit of being a buy-and-hold investor in the respective futures of the commodities outlined.
That is to say: to what degree does the fact that you can’t do anything but sit permanently in managed futures detract from the returns you might otherwise expect from the spot performance of the commodity itself?
What the chart shows, then, is that in some commodities, like in lead this year, you can be lucky — there’s no additional cost borne from holding futures. You get the upside from the spot performance, you don’t get any downside from the futures.
In other commodities, like live cattle in 2009, you can lose on the performance of the futures, but not anymore than you would have done from riding the spot price.
But in other scenarios, like oil, you might see the spot price incrementally outperform your futures position in the period — in so much as spot prices go up, while your returns end up flat.
And in yet other scenarios, like natural gas this year, your total returns can fall beyond even those of the spot price — i.e. the futures nature of your position just escalates your losses.
As for the benefits, the chart shows that only three commodities in the GSCI basket this year had term structures (for instance, backwardation) that benefited buy-and-hold investors.
Overall, as Nadig explains, the chart shows to what degree natural gas buy-and-hold investors were the biggest losers in commodities this year (our emphasis):
…in the case of crude oil, playing crude through futures costs you almost 60 percent. Spot crude has essentially doubled this year, moving from the low $30s per barrel to a recent holding pattern around $70. Futures investors missed out on that entire run, thanks to having to roll their positions each month. But the biggest goat by far here has to be natural gas. While in “what if” terms crude oil investors got robbed, the reality is they’ve essentially stayed even, maybe even up a few percent, depending on when you got in.
Natural gas investors have had absolutely the worst of all worlds. Not only has the spot price just been slaughtered this year—from around $6/MMBTU at the beginning of the year to around $3 now—the contango in the natural gas market has been crippling, meaning not only were you an idiot for being in natural gas, you were even more of an idiot for being in natural gas futures.
As for the relevance of all that to the ETF market, Nadig says:
Well, for the first time in history, there’s a very real chance you could have participated in this craziness directly with your Aunt Mildred’s retirement account or your daughter’s college fund. Every one of the commodities I’ve mentioned has a futures-based ETF available (you can even invest in live cattle if you’ve got access to London, with the ETF Securities Live Cattle ETF (London: CATL).
Related links:
The problem with commodity ETFs - FT Alphaville
Someone’s smarter than the average natgas bear – FT Alphaville