The ETF commodities conundrum

Sharp falls and rebounds in commodities prices have caused concern among investors. Paul Burgin looks at how ETPs have been affected by the volatility

The recent commodity sell-off in May sparked much activity and debate among exchange-traded product investors. The sharp dip in silver prices prompted many to sell out of both physical and futures-based ETCs, with the effects spilling over into other commodity assets. The incident also highlighted differences in product design and performance.

Strengths and weaknesses
The attributes of ETPs tend to expose both strengths and weaknesses in investment strategies and the products themselves when markets turn suddenly. The total exposure provided by ETP products offers no place to hide for medium and long-term investors. Actively managed funds can diversify and reduce exposure, whereas index tracker, spot and forward-based investments cannot.

The intraday tradability of ETPs is beneficial for the individual investor confident of their timing and tactical skills. But tradability also offers other investors an equally easy exit route. Investors pulling out of physically-backed products could potentially push down prices, tempting others to pull out too.

Futures-based products can have their advantages, as investors need not buy, store and then trade perishables or bulky commodities. Yet the performance of these vehicles can differ dramatically from spot prices once roll yields come into play. So it proved in recent weeks when commodity prices rose sharply towards the end of April, only to crash, rise and dip again by mid-May.

Tarnished silver
Investors in silver experienced the sharpest drops. The metal rose steadily throughout April to around $49 per ounce only to fall to $34, recover slightly and then drop again to nearer $32. Gold followed a similar, though less dramatic, pattern. London prices rose in April to $1,540 and then dipped below $1,490. Gold holders are nonetheless better off than they were six weeks ago. However, silver investors are nursing a loss, while oil and other energy commodities were also hit.

BlackRock calculates that 768 exchange-traded vehicles covered broad indices and individual commodities with assets of $220bn at the end of April. The year-to-date four month inflows of $9bn stack up well against a total of $21bn last year. Precious metals dominate with $156bn of total assets.

Physical gold is increasingly the product of choice, although flows have weakened considerably of late. The biggest commodity inflows this year have been to broad index, agriculture and industrial metals products.

Nonetheless, the growing commodity space took a knock at the end of April. Investors in ETF Securities’ ETC platform were quick to sell out as silver prices fell. Martin Arnold, senior analyst at ETF Securities, believes panicky marginal investors were the first to move. Weaker than expected economic data and continued concerns about European sovereign debt issues may have caused jitters, but were unlikely to be the only factor contributing to the large drop in silver prices and the swift exit by ETC investors.