Kamis, 27 September 2012

Inflation...?? Hyperinflation...???...Five Surprising Facts About Hyperinflation..??....Inflation is a common environment for most economies as prices tend to rise as time passes. Governments and central banks around the world mold policies in an effort to curtail inflation and keep it under control. Another less common phenomenon is deflation, or the general decline in prices (and wages) and inflation rates fall below zero. Still an even more rare event is hyperinflation, an issue that does not ail nations often, but when it does, it leaves behind significant damage. For those unfamiliar with hyperinflation and its impact on a surrounding economy, we outline five surprising facts about the phenomenon...??...1]. Results from large increase in money supply: 2] Lack of confidence in currency...3]...More closely linked to deflation than inflation:..4]...Hyperinflation still occurs today:...5]....The U.S. is currently the largest hyperinflation risk:..>>> ..How to Build a Hyperinflation Portfolio...??? 1] Portfolio Snapshot.2] ..Holdings Overview...3] Historical Return Analysis..??..4]..Portfolio Expenses......The threat of hyperinflation in our current economic state is very minimal, though it is true that the U.S. is currently at the highest risk for such a phenomenon among major developed countries. Preparations for a hyperinflationary environment have heated up among some investors in recent years, as the consistent money printing from the Fed has many worried that inflation will spike at some point in the near future. For those who fear a major jump in inflation, we outline an all ETF portfolio to protect yourself from the havoc that inflation can wreak on your holdings....>>...The adjacent table provides historical results for each component of this portfolio, as well as backtested results (as available) for the entire portfolio during 2008, 2009, 2010, and 2011. The table also shows how this portfolio performed relative to a popular stock market benchmark (SPY) and bond benchmark (AGG). Not surprisingly, the components of this portfolio struggled in 2008 amidst a broad market recession. In 2009 and 2010, the equity holdings in this portfolio reclaimed much of the ground lost during 2008. The dismal equity returns in 2008 highlight the importance of maintaining an allocation to fixed income ETFs in this portfolio. The recent economic downturn also had a significant impact on commodity prices, as evidenced by the loss of DBC over the most recent year. TIP has remained relatively stable during the recent market turmoil, as has GLD, which is the top performer during the last three years...>>...The Ten Commandments of Commodity Investing...???..>>>

Wealth Wire..thank for the friendly info

https://mail.google.com/mail/u/0/?hl=id&shva=1#inbox/13a08cbc09900132

How to Build a Hyperinflation Portfolio

Posted by Wealth Wire - Wednesday, September 26th, 2012


http://www.wealthwire.com/news/finance/3902?r=1

The threat of hyperinflation in our current economic state is very minimal, though it is true that the U.S. is currently at the highest risk for such a phenomenon among major developed countries. Preparations for a hyperinflationary environment have heated up among some investors in recent years, as the consistent money printing from the Fed has many worried that inflation will spike at some point in the near future. For those who fear a major jump in inflation, we outline an all ETF portfolio to protect yourself from the havoc that inflation can wreak on your holdings.

Portfolio Snapshot

First things first, here are the ETFs that we have chosen for this particular portfolio.
TickerETFAsset TypeAllocationExpense Ratio
IEZ iShares Dow Jones U.S. Oil Equipment & Services Index Fund Domestic Equities 10.0%    0.48%
MOO Market Vectors Agribusiness ETF Domestic Equities 10.0% 0.59%
GDX Market Vectors TR Gold Miners ETF Domestic Equities 10.0% 0.55%
HAP Market Vectors Hard Assets Producers ETF Domestic Equities 10.0% 0.65%
TBF ProShares Short 20+ Year Treasury Inverse Fixed Income 10.0% 0.95%
TIP iShares TIPS Bond Fund Fixed Income 10.0% 0.20%
GLD SPDR Gold Trust Commodities 20.0% 0.40%
DBC PowerShares DB Commodity Index Commodities 20.0% 0.83%
Weighted Average Expense Ratio 0.59%

As can be seen above, there are really only two funds that are unrelated to the commodity industry. This is because commodities have been historically strong assets for fighting inflation, leading us to choose two direct commodity products, as well as four others that invest in commodity producers.

Holdings Overview

Below is a brief overview of each component of this portfolio.
  •  IEZ: This ETF invests in companies that are suppliers of equipment or services to oil fields and offshore oil platforms, such as drilling, exploration, engineering, logistics, and platform construction. IEZ has more than 40 individual holdings, including companies like Schlumberger and Halliburton. Companies engaged in activities related to oil drilling often see increases in demand for their services during periods of high inflation.
  • MOO: This ETF invests in companies that generate the majority of their revenues from the business of agriculture, including agricultural chemicals, operations, equipment, and livestock. The legendary Jim Rogers recently advised investors to “sell your houses, move to Saskatchewan, buy a tractor and some farmland, and start farming,” as he anticipates an “inflation holocaust” sending agriculture prices skyrocketing.
  • GDX: This ETF invests in companies engaged in mining for gold, and has significant holdings in Canada, South Africa, the U.S., Australia, the UK, and Peru. Since gold generally performs very well in inflationary environments, companies engaged in its discovery tend to see increases in revenue as well [see also Three Reasons Why Gold Is Overvalued].
  • HAP: This ETF tracks an index developed in conjunction with famed commodity investor Jim Rogers, and invests in companies engaged in the production and distribution of hard assets and related products and services. HAP’s holdings include companies engaged in the energy, agriculture, precious metals, and industrial metals industries. This ETF has investments in more than 40 countries, with the most significant being the U.S., Canada, and the UK.
  • TBF: This ETF offers inverse exposure to the Barclays Capital 20+ Year U.S. Treasury Index. Since Treasuries tend to lose value in hyperinflationary environments, this ETF provides an opportunity to profit from drops in value. It is noted that TBF uses complex financial instruments to achieve inverse exposure. As a result, compounding of returns may lead to erosion of returns over extended periods of time. To avoid this, investors should develop and implement a rebalancing plan.
  • TIP: This ETF invests in Treasury Inflation-Protected Securities (TIPS). These securities provide protection against inflation because the principal of a TIPS rises with inflation, as measured by the Consumer Price Index (CPI). Unlike most traditional fixed income investments, TIP offers a guaranteed real return that will not be eroded in a high inflation environment.
  • GLD: This ETF invests in and physically stores gold bullion. Gold has historically been a very strong inflation hedge, appreciating in value as investors seek refuge from other depreciating currencies. Unlike equities or bonds, gold has no potential for dividend or interest payments, so any returns will be generated through increases in the market price level of the metal [see also Why No Investor Should Own GLD].
  • DYY: This ETN offers leveraged exposure to a basket of futures contracts, including wheat, corn, light sweet crude oil, heating oil, gold, and aluminum. In hyperinflationary environments, prices for these commodities can be expected to rise, pushing up the value of this product.

Historical Return Analysis

Ticker2008200920102011
IEZ -58.7% -63.6% 31.8% -7.6%
 MOO -50.9% 58.7% 23.0% -11.4%
GDX -26.1% 36.7% 33.9% -16.1%
HAP n/a 42.5% 16.5% -11.7%
TIP -0.5% 9.0% 6.1% -29.6%
TBF n/a n/a -12.4% 13.3%
GLD 5.0% 24.0% 29.3% 9.6%
DBC -31.7% 16.2% 11.9% -2.6%
Portfolio n/a n/a 18.1% -4.9%
Compare to SPY -36.7% 26.3% 15.0% 1.8%
Compare to AGG 7.6% 3.3% 6.4% 7.7%
The adjacent table provides historical results for each component of this portfolio, as well as backtested results (as available) for the entire portfolio during 2008, 2009, 2010, and 2011. The table also shows how this portfolio performed relative to a popular stock market benchmark (SPY) and bond benchmark (AGG).
Not surprisingly, the components of this portfolio struggled in 2008 amidst a broad market recession. In 2009 and 2010, the equity holdings in this portfolio reclaimed much of the ground lost during 2008. The dismal equity returns in 2008 highlight the importance of maintaining an allocation to fixed income ETFs in this portfolio.
The recent economic downturn also had a significant impact on commodity prices, as evidenced by the loss of DBC over the most recent year. TIP has remained relatively stable during the recent market turmoil, as has GLD, which is the top performer during the last three years.

Portfolio Expenses

Although this portfolio is not intended to be held over an extended period of time, we made an effort to minimize costs in selecting the individual components. Since many ETFs in this portfolio are not “plain vanilla” funds, they maintain expense ratios higher than some exchange-traded products. But while the weighted-average expense ratio falls on the higher side of ETF investing, it remains well below fees charged by traditional actively-managed mutual funds (which can exceed 1.0%). The impact of this reduced cost structure over a two-year time horizon is significant [see also The Ten Commandments of Commodity Investing]:
  Growth of $1 Million Over 2 Years @ Annual Return Of
PortfolioExpense Ratio5%10%15%
Black Swan Hyperinflation Portfolio 0.59% $1,090,187 $1,197,099 $1,309,011
Actively-Managed Mutual Fund Portfolio 1.00% $1,081,600 $1,188,100 $1,299,600

While this can certainly be used as an all encompassing group of holdings, those wishing to protect themselves from inflation can also use this model portfolio as a smaller part of their overall group of holdings. It should also be noted that this portfolio is useful in any kind of inflationary environment not just hyperinflation.
*Post courtesy of Jared Cummans at Commodity HQ.

Five Surprising Facts About Hyperinflation

Five Surprising Facts About Hyperinflation

Inflation is a common environment for most economies as prices tend to rise as time passes. Governments and central banks around the world mold policies in an effort to curtail inflation and keep it under control. Another less common phenomenon is deflation, or the general decline in prices (and wages) and inflation rates fall below zero. Still an even more rare event is hyperinflation, an issue that does not ail nations often, but when it does, it leaves behind significant damage. For those unfamiliar with hyperinflation and its impact on a surrounding economy, we outline five surprising facts about the phenomenon [see also Doomsday Special: 7 Hard Asset Investments You Can Hold in Your Hand].
  1. Results from large increase in money supply: Most often, hyperinflation is a direct result of a large increase in the money supply of a particular nation. When a bank begins to print money, the currency quickly becomes devalued, leading to a deadly spiral in which more money is require to fund government activities (sound familiar?). This leads to an increase in prices around said nation that only continues to accelerate. Though there is no specific benchmark for hyperinflation, many economists feel that it can be described by monthly inflation of more than 50%. At those rates, a $10 CD today would cost you around $1,300 in just one year.
  2.  
  3. Lack of confidence in currency: Working off of the last point, hyperinflation is also caused by a general lack of confidence in a particular currency (this one sounds familiar too). When consumers do not trust a currency it can quickly lose its value, especially as investors look elsewhere to store their capital. Note that this process only works in fiat currencies, as printing money at will (only a possibility of paper money) causes people to rightly question the value of said currency. Though the U.S. has long been off of the gold standard, many analysts and investors are calling for a return to a backed currency given the risks associated with paper money and the Fed’s ability and willingness to print dollars at will [see also Commodity Plays For the End of Fiat Currency].
  4. More closely linked to deflation than inflation: This is one of the more surprising facts that investors learn about hyperinflation. Common sense would tell you that the name “hyperinflation” simply suggests a very extreme case of inflation. While this is technically true, hyperinflation is more closely related to deflation, as many view it “as the result of a failed attempt at printing money to avoid the deflation that would be caused by austerity” writes Max Nisen.
  5. Hyperinflation still occurs today: Many of the examples of hyperinflation date back to the early 20th century or in post-WWII period, so many associate this phenomenon with history. Unfortunately, hyperinflation is still a very real threat to some countries and currently afflicts economies around the world, with the chief example being Zimbabwe. Following a civil war and major confiscation of farmland in the mid to late 2000s, this nation endured (and is still enduring) unfathomable hyperinflation with its peak annual inflation rate clocking in at 6.5 quindecillion novemdecillion percent. For those of you keeping score at home, that is the number 65 followed by 107 zeros. “To get a handle on it, realize that it’s equivalent to inflation of 98% a day. Prices double every 24.7 hours. Shops have simply stopped accepting Zimbabwean dollars” writes Steve H. Hanke. The nation has since abandoned its previous currency as it was deemed entirely irrelevant [for more commodity news subscribe to our free newsletter].
  6. The U.S. is currently the largest hyperinflation risk: If you did not already pick up on the hints above, the U.S. has been exhibiting early habits of countries that fall into hyperinflation for quite some time now. Though the risk of this actually coming to fruition is very small, UBS recently stated that “A significant deterioration of the fiscal situation or a significant expansion of the monetary policy stance in the large-deficit countries could lead us to increase the probability we assign to the risk of hyperinflation”. It’s probably something that we will never have to deal with, but it should be noted that the our nation is currently at risk for future hyperinflation.
Don’t forget to subscribe to our free daily commodity investing newsletter and follow us on Twitter @CommodityHQ.
Disclosure: No positions at time of writing.
This entry was posted in Academic Research, Asset Allocation, Inflation and tagged , . Bookmark the permalink
 
Commodity HQ is not an investment advisor, and any content published by Commodity HQ does not constitute individual investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities or investment assets. Read the full disclaimer here.

Related News Stories

 Three Reasons Why Gold Is Overvalued

Three Reasons Why Gold Is Overvalued


The past few months have put gold in the spotlight, and for good reason. The metal has shot up from below $1,000 per ounce in 2009, all the way to its current levels above $1,500. As markets around the world continue to falter, gold has seen a massive amount of inflows as it has long been the popular safe haven investment. Now that the Swiss franc is pegged to the euro, many consider gold to be the last remaining safe haven, as the once strong franc will now be dictated by the movements of the drowning euro. But with gold seeing its price nearly triple in the last several years, many investors are formulating strong opinions as to whether or not the precious metal is overvalued and due for a huge correction in the near term [see also Jim Rogers Says: Buy Commodities Now, Or You’ll Hate Yourself Later].

In the current market environment, equities are exhibiting extreme volatility, and bonds yields are at an all time low, forcing investors to find their returns elsewhere. With so much instability, and the strong returns that gold has posted, it makes sense that it has surged in popularity over the last three years. Yet, as the commodity continues to climb, it has become clear that it is overvalued by some metrics. (By the way, if you’d like to get free daily updates on gold, silver, and other hard asset investments, consider subscribing to Commodity HQ’s free daily e-mail newsletter.) Below, we outline the specific reasons why gold’s price is inflated, and what makes this asset class one that investors need to keep their eye on for bubbles in the near future:

1. Gold is Gold is Gold

 

Let’s look at the facts. Gold is finite mineral that is considered a rare find, giving it such a high price per ounce. It does not pay dividends and it has no underlying benchmark, it simply sits in lumps in vaults all over the world. The past few years has not seen a massive change in the amount of gold in existence; if there were to somehow be a massive loss of gold around the world, it would certainly make sense to see its price skyrocket. Instead, the metal is just as rare today as it was 20 years ago, you could even argue that with all of the mining giants around the world that gold has become more abundant [see also Warning: Ignore Bill Gross’ Hard Money Prediction At Your Own Risk].

Nothing about gold has changed in the last few years, so why the massive appreciation in price? Any other commodity, like lumber or cotton, that saw this kind of exponential jump would be under major scrutiny. And cotton, in fact, did bottom-out after seeing its highest prices in history, putting it at the top of headlines for quite some time. Investor speculation and market scares have all contributed to gold’s meteoric rise, and if equities were ever to get their act together, gold would be in for a massive sell-off. Its price is held up by flimsy markets and a cloudy future, but if skies were to ever clear for our economy, investors would pile into equities, leaving the inflated gold to plummet.

2. Gold is Overbought

One of the most popular benchmarks for gold investment comes from the SPDR Gold Trust (GLD), an ETF that offers exposure to physical bullion. Looking at the average volumes of GLD, it is clear that the metal has been overbought as of late. In August of 2011, GLD had an average daily volume of 33.4 million, which is a huge increase compared to ADVs of 7.4 million and 9.8 million in August of ’09 and ’10, respectively. In fact, last month saw an astonishing increase in volume of over 244% from the previous year’s August and 351% compared to August ’09, leaving screaming evidence of the unnatural volumes in gold. Because markets have been so abysmal, gold has seen an extremely high amount of trading, but this is not the first time gold has seen this kind of move [see also Doomsday Special: 7 Hard Asset Investments You Can Hold in Your Hand].

In 1980, gold prices experienced a very similar pattern that we see today. In the late 70′s markets dealt with inflation and tumultuous equities, while investors piled into gold, causing its price to jump from around $200 per ounce in 1978, all the way past $800 in 1980. With an exponential rise in gold prices, increasing fourfold in fact, the metal crashed in the subsequent two years all the way back below $400 per ounce, creating painful losses for a number of investors. Gold prices are exhibiting an eerily similar pattern today, as prices have jumped threefold since 2006 in an exponential fashion. If investors were to ever consider the phrase “history repeats itself”, now may be a good time to keep a close eye on gold.

3. Portfolio Rebalancing

As pointed out by Simon Oates from Financial Expert, gold may be poised for a loss simply based on the portfolios of a number of individuals and institutions alike. When it comes to portfolio allocations, a well-diversified basket of holdings is key, and that means that investors will try and spread their exposure across numerous asset classes. Commodities, like gold, are typically given a small portion of a portfolio usually ranging between 5% and 10% of total assets. However, for those investors lucky enough to have held a product like GLD over the last five years, they have seen not only massive gains, but now a major increase in their commodity allocations as well [see also The Guide To The Biggest Companies In Every Major Commodity Sector].

As a result, gold, an asset that is often meant for the “buy and hold” investor, now makes up a much larger percentage of many portfolios than what was originally planned. While investors are likely very aware of this, it is difficult to sell out of an asset that has multiplied so rapidly in recent years. Soon enough, however, it will come time to scale back on the now too-large commodity allocations and prompt a healthy rebalance. This could send gold for a massive drop as a number of investors sell out to keep their portfolio reasonably diversified and avoid putting too much in the precious metal.

Final Thoughts

One of the most important things to remember is that while gold may be overvalued, that does not mean that it is a bad investment, but is rather a factor to keep an eye on. It would be absurd to call gold a bad investment given its historic gains in recent years, but that also does not mean that it is safe at its current levels. For as long as market volatility persists, gold will be able to keep its high prices afloat, but when the day comes where equities finally break ground, this shiny metal will likely suffer a massive drop. When that will happen though, could be anywhere from one year to decades depending on who you ask. Instead, investors simply need to keep a close eye on their gold holdings, and be ready to pull the trigger if and when our economy pulls itself out of its downward spiral and confidence once again returns to the markets [see also Major Countries Burn Up Crude Reserves: Big Oil In Trouble?].
Don’t forget to subscribe to our free daily commodity investing newsletter and follow us on Twitter @CommodityHQ.
Disclosure: No positions at time of writing.
This entry was posted in Asset Allocation, Commodity ETFs, Exclusive, Gold, Inflation, Precious Metals and tagged , . Bookmark the permalink.
Commodity HQ is not an investment advisor, and any content published by Commodity HQ does not constitute individual investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities or investment assets. Read the full disclaimer here.

Related News Stories

Why No Investor Should Own GLD


Those looking for a reason to add commodity exposure to their portfolio will find gold’s massive historical return to be heavily persuasive. This precious metal has quickly become one of the few safe haven investments left on the market as investors will typically flock to gold when equities falter. Some swear by futures contracts, while others are more partial to obtaining their gold positions by investing in the mining sector, which can offer offer lucrative opportunities as these securities often have high betas. Still, others have embraced exchange traded products as their primary means of establishing a position in this commodity [see also Three Reasons Why Gold Is Overvalued]. 

No ETF has been more instrumental to gold’s rise than the SPDR Gold Trust (GLD), which just so happens to be the second largest ETF in the world by assets. With over $70 billion in AUM and an average daily volume topping 11.9 million, GLD has established itself as an investor favorite and as one of the most popular funds around. But the fund is not without its drawbacks and for those looking to establish long term exposure to gold, there is one fund that offers a more enticing investment thesis, the COMEX Gold Trust (IAU).

The Gold Case

First and foremost, this is not an article bashing GLD. This has nothing to do with some of the outlandish speculation that GLD actually holds no gold or any other conspiracy involving this ultra-popular ETF. Instead, this article is dedicated towards long term investors who are seeking to add gold exposure to their portfolio. It is also important to note that the article is specifically designated towards “buy and hold” investors, not traders.

 

If it seems like these two funds are nearly identical on the surface, its because they are. Both funds track physical gold bullion with GLD representing approximately 1/10th an ounce of gold while IAU represents about 1/100th an ounce of the precious metal. When it comes to liquidity, GLD takes the cake. The fund has a very active options market, almost eight times the assets of IAU, and a daily volume that is nearly double its smaller competitor. This makes GLD a prime trading instrument and it has certainly produced massive returns for a number of investors. But as it was stated earlier, this article focuses on long-term investors, where IAU has a clear edge [see also Does GLD Really Hold Gold, Or is it a Scam?].

After all is said and done, it all boils down to a few measly basis points; IAU charges 0.15% less than GLD, making it the ideal long term hold. Think that number sounds insignificant? Consider two different million dollar portfolios, one which is wholly invested in GLD and the other doing the same for IAU (obviously a diversification nightmare but stick with me). The GLD portfolio will incur annual expenses of $4,000, while its competitor will shell out only $2,500. That $1,500 difference seems miniscule for just one year, but drag it out over a 30 year investment and the difference between fees amounts to $45,000, or 4.5% of your original investment. Saving yourself a quick 4.5% could have been as simple as buying IAU over GLD.

Also consider that IAU’s cheaper fees will mean that it will generally outperform its competitor. Though the difference will be slight, there will be a noticeable delta between the two when the time frame is expanded to multiple decades. Note that GLD’s size and trading volume can tweak these numbers a bit, but evidence shows that assets may be headed towards IAU, which could erase this issue in time. IAU slashed its expense ratio in mid 2010, making 2011 its first full trading year at 0.25%. Last year, IAU saw cash inflows of over $2.7 billion, while GLD saw outflows of $372 million, suggesting that long term investors have begun to catch on to the money saving trend between these two ETFs [see also Seven Reasons To Hate Gold As An Investment].

Final Thoughts

As mentioned earlier, GLD is likely the supreme trading instrument for more active investors. The fund offers unmatched liquidity and a strong options market. But when it comes to long term investors, IAU emerges as a clear winner. With a wide range of individuals and analysts predicting gold’s rise to continue through out the years, a number of investors have added exposure to their retirement accounts or at least some kind of long term basket of holdings. For those who have adopted a gold strategy that will stretch over multiple years, consider the money that could be saved with IAU and the difference that a few seemingly insignificant basis points can make.

Don’t forget to subscribe to our free daily commodity investing newsletter and follow us on Twitter @CommodityHQ.

Disclosure: No positions at time of writing.
This entry was posted in Commodity ETFs, Exclusive, Gold, Precious Metals and tagged , , . Bookmark the permalink
 
Commodity HQ is not an investment advisor, and any content published by Commodity HQ does not constitute individual investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities or investment assets. Read the full disclaimer here.

Related News Stories


The Ten Commandments of Commodity Investing


Investor interest in commodities has surged in recent years, the result of both a prolonged rally in natural resource prices and the development of new vehicles that facilitate access to this asset class. Specifically, the launch of a robust lineup of exchange-traded products that utilize both physical commodities and commodity futures contracts has brought commodities to the masses; they’re no longer reserved for the largest and most sophisticated investors [see also Jim Rogers Says: Buy Commodities Now, Or You’ll Hate Yourself Later].

Commodities have obvious appeal to active investors looking to generate profits from short-term price movements; the volatility of this asset class is ideal for risk-tolerant individuals who actively monitor their positions. But commodities may also have appeal to the long-term, buy-and-hold crowd; this asset class has the potential to bring both diversification and return enhancement to traditional stock-and-bond portfolios.

Of course, along with those potentially appealing attributes comes plenty of risk; the path to commodity exposure is full of potential obstacles and pitfalls that can erode returns and lead to a less-than-optimal investing experience. Here are ten rules of thumb that will help you achieve a more successful experience investing in commodity markets [see also Warning: Ignore Bill Gross’ Hard Money Prediction At Your Own Risk]:

1. Remember the Contango…

Perhaps the most common–and most dangerous–misconception about commodity ETFs and ETNs is that these products offer investors exposure to the spot prices of the underlying commodities. While some physically-backed precious metals ETFs such as IAU and SLV do hold physical bullion, the vast majority of commodity ETPs on the market achieve the targeted exposure through the use of futures contracts.
That is very important to note, because it means that the returns generated will ultimately depend on three factors:
  • Changes in spot price of the commodity
  • Slope of the futures curve
  • Interest earned on uninvested cash
It’s not uncommon for the second point on that list to be the driving force, and the reason why returns on commodity ETPs can deviate significantly from a hypothetical investment in the spot commodity [see also 25 Things Every Financial Advisor Should Know About Commodities].

2. …And Keep It Away

For an investor who solely invests in futures contracts, contango may not be as big of an issue. But given the fact that commodity ETPs have soared in assets in recent years, there are a large amount of people who rely on these products for their commodity exposure, and it is highly likely that a number of them have been burned by contango. A futures-based ETP follows a strict process which, when combined with contango, slowly but surely destroys a position. The most popular kind of commodity exchange traded product is a first generation futures fund; one that simply invests in front-month futures and features an automated roll process. Here is where the issue comes into play.

When and ETP’s contract is about to reach maturity, the fund executes an automated roll process so as to avoid delivery. When futures are contangoed, this forces the particular fund to sell the contract low, and buy the next contract for a higher price, erasing value with the blink of an eye. When this process is dragged out over several months, these funds have a nasty habit of producing some rough returns. But how can you keep away from such a common anomaly?

It is first important to remember that first-generation futures funds, like UNG and USO, should be used as trading instruments. Their automated roll process will always fall prey to a contangoed environment, and therefore it is not often wise to establish a long term position in such a fund. Instead investors should measure their holding periods of these products in days and hours, rather than weeks and months, to help avoid the pitfalls of the auto-roll. But for those who are uncomfortable with actively trading a fund, there are now a wide variety of ETPs that are focused on eliminating contango. These next-generation products will often hold several futures contracts at once and their roll process does not always involve buying the next month’s contract, but rather one that matures further into the future.

A quick glance at the index description of a futures-based fund will tell you if it is utilizing the dangerous front-month strategy, or if it is using alternative means to avoid contango. Also note that investors can use physically-backed products to avoid this issue, though that space is generally limited to precious metals [see also .

3. Do Not Bear False Witness Against Commodity ETNs

Most investors are aware that there are distinctions between exchange-traded funds and exchange-traded notes; ETFs hold a basket of underlying securities and may experience tracking error, while ETNs are debt securities that will expose investors to the credit risk of the issuing institution [see also Three Reasons Why Gold Is Overvalued].
Most investors tend to gloss over the differences between these two product types, since they generally function in almost identical fashion. When it comes to accessing commodities, however, the differences between these two product structures can be significant. For starters, tracking error can become a big issue with products that regularly “roll” futures contracts to avoid taking physical possession; ETFs that are continuously buying and selling futures contracts are likely to deviate slightly from their target index. ETNs don’t have that concern, since there are no underlying holdings; the value of these securities simply moves along with the index.
It should be noted that ETNs can also avoid the fees that come along with rolling futures contracts and implementing a futures-based investment strategy. ETFs incur costs in the form of brokerage commissions whenever they sell or buy futures contracts; ETNs simply calculate the change in value of the underlying index, and the value of the note adjusts accordingly [see also 25 Ways To Invest In Natural Gas].
Basically, it is worthwhile to do your homework into the various structures at your disposal for accessing commodities; the choice you make can have a potentially significant impact on your credit risk, tax liabilities, and tracking error. Most investors look at ETNs with skepticism, wary of the credit risk contained. That risk component certainly shouldn’t be ignored completely, but it is worth noting that there are some appealing attributes of the ETN structure as well.

4. Know Thy Tax Ramifications

 

The issues of tracking error and expenses aren’t the only place where the choice of structure matters; the difference between a commodity ETF and a commodity ETN can translate into sizable discrepancies in tax obligations. Most commodity ETPs that actually hold futures contracts–meaning the non-ETN segment of the universe–are structured as partnerships for tax purposes. That means that these securities are taxed at a blended rate between short-term and long-term capital gains (the 60/40 split results in an effective rate of about 23%). Moreover, these securities incur a tax liability annually regardless of whether shares were sold. And they require advisors to fill out a K-1, which can be an administrative headache to some [see also Dividend Special: Top Companies In Every Major Commodity Sector].
Compare all of that to the simplicity of commodity ETNs, which are generally only taxed upon sale at the applicable short-term or long-term rates. Moreover, commodity ETNs are reported of a form 1099; there’s no K-1 to deal with on these products.
One other note on the subject of commodities and taxes; it’s important to note that physically-backed ETPs aren’t the only products that are subject to some strange rules. For example, it’s important to keep in mind that physically-backed precious metals ETFs, such as the ultra-popular GLD and IAU, are subject to being taxes as collectibles [see also 25 Ways To Invest In Silver].

5. Thou Shalt Not Commit “Energy Bias”

When it comes to commodity investing, many investors commit the sin of energy bias, whereby the majority of their commodity holdings fall under the umbrella of an asset like crude oil or natural gas. To be fair, energy products are among the most popular in the commodity world, but exhibiting a bias towards these investments can have some adverse effects on your portfolio. Energy products are quite often highly correlated to the movement of general markets, meaning that they will move closely in line with something like the S&P 500. One of the main reasons that commodity exposure is essential to a portfolio is the low correlation and diversification benefits that these investments offer. An energy-heavy portfolio will likely only steepen your losses on bad days which may not be enough to be erased by days in the black [see also The Ultimate Guide To Natural Gas Investing].
Energy investments are obviously very important, as the majority of these commodities offer relatively inelastic demand because we cannot survive without them in our daily lives. But with these futures and products being particularly volatile, committing a bias may only hurt you in the long run. Instead, it is important to remember to keep vital energy holdings in check with other commodities like precious metals or softs. This way, a portfolio will still reap all of the benefits offered from energy, but will also gain the diversity of commodities tied to vastly different price drivers that offer sometimes zero correlation to major benchmarks.

6. Thou Shalt Not Be Stolen From

Commodity investing can be an expensive venture, and if one is not careful, it can be easy to erase value through expenses like commissions and other fees associated with trading. One of the first things every investor should do is take a look at their strategy and then research if there is a cheaper way to gain the exposure. Often times, there is a corresponding exchange traded product to a futures-based strategy that can offer a much more enticing expense structure. The constant shifting of positions required by commodity investing can quickly eat away bottom-line returns, as commission fees rack up quickly, not to mention the capital gains on a short term trade. Failing to consider one’s expenses is essentially allowing the markets to steal from you [see also Why Commodities Belong In Your Portfolio].
When considering your commodity trading strategy it is important to see the bigger picture. Is there a fund that trades the same contracts for a lower price? Is there a company that offers good exposure to a commodity that doesn’t require the constant movements that are needed for futures investing? And most important of all, is there a cheaper way to employ the same strategy? While a few measly basis points may not seem like a lot, consider a portfolio of $1,000,000. Let’s say that each year that portfolio is subject to fees of 1% of total assets (not an uncommon expense for active traders). If one were to eliminate 0.25% from that figure, you could save $2,500 every year. Drag that out over ten years of trading and you have an extra $25,000 sitting in your pocket. Commodity investing can be expensive, but there are plenty of ways to beat the fees, it simply takes diligent and careful research.

7. Consider “Indirect” Positions In Commodities

 

Investing in commodities generally means holding either the actual physical natural resources (generally gold or another precious metal) or holding futures contracts that are linked to the commodity. But there is another option for tapping in to this asset class that takes an indirect route to commodities; stocks of companies whose operations revolve around the exploration, extraction, and sale of commodities. For example, stocks of gold mining firms can be seen as an indirect investment in gold [see also The Ultimate Guide To Gold Investing].
These companies tend to exhibit relatively strong correlations to the underlying resources. That’s because the profitability of these companies generally depends on the market price for the goods they sell. In the case of a gold miner, higher gold prices will generally translate into higher earnings since they will receive more money for each ounce of the metal they uncover and sell. Similarly, oil stocks tend to perform well when crude prices climb and timber stocks do well when lumber prices are elevated. The benefit of this approach is that stocks don’t exhibit contango that is common in commodity futures contracts–often to the detriment of positions in these securities.
It should be noted, however, that stocks of commodity-intensive companies will not always exhibit perfect correlation with the underlying natural resource. These stocks are, after all, stocks–meaning that they will be impacted by movements in broad global equity markets. That may diminish one of the appealing attributes of commodities; the potential for diversification benefits and a low correlation with stocks and bonds [see also Six Academic Studies Every Commodity Investor Must Read].

8. Do Not Covet Thy Neighbor’s Methodology

The old saying is that there is more than one way to skin a cat. That’s certainly applicable when it comes to investing in commodities; there are a number of different ways to tap into this asset class. Even in a futures-based approach to investing in natural resources, there are multiple options for crafting a commodity position. The details of an investment in commodities may seem insignificant, but they can actually end up having a meaningful impact on bottom line returns and volatility.
For any given commodity, there are generally multiple futures contracts that are distinguished by the maturity date. For example, there are crude oil contracts traded on the NYMEX expiring each month of the year. Other futures have four or five maturity points in each calendar year, and in many cases there are contracts listed for years in advance (it is possible to, for example, to invest in a crude oil futures contract that expires in 2015) [see also Crude Oil Guide: Brent Vs. WTI, What’s The Difference?].
Exchange-traded commodity products can generally be categorized into three groups, depending on which type of futures contracts they hold:
  • Front Month Futures
  • Rolling 12-Month Futures
  • “Dynamic” Futures
Many of the commodity ETPs on the market focus on front month futures contracts, rolling exposure as the contracts approach expiration and using the proceeds to invest in the second month futures contracts. The benefit of this strategy is that front month futures tend to exhibit the strongest correlation to spot prices in the short term, meaning that products such as USO and UNG are optimal for those expecting to be in a position for a short period of time.
The downside is the potential for the adverse effects of contango; because products that focus on front month futures must roll holdings on a monthly basis, they are vulnerable to more frequent return erosion resulting from an upward-sloping futures curve. ETPs that spread exposure across 12 months of futures contracts, on the other hand, may not experience the same degree of return erosion since only a fraction of the portfolio changes each month. In return for that benefit, these products might not exhibit quite the same correlation to spot prices [see also.
Finally, there are a growing number of ETPs that don't stick to a predetermined roll strategy, instead examining observable market prices to determine which contracts are optimal for minimizing the adverse impact of contango or maximizing the benefit of backwardation [see also Should You Buy Gold Before QE3 is Announced?].
While these approaches and the products that employ them may seem similar, they can lead to very different results. Make sure you understand the nuances of each strategy before jumping in to a commodity ETP.

9. Do Not Swear Falsely By The Name “Inflation Hedge”

 

A large part of the appeal of investing in commodities is related to inflation; this asset class is generally assumed to be an effective way to protect investor portfolios from the adverse impact of inflation. Because inflation by definition means an increase in prices, this can obviously be a boost to natural resource prices. Rising prices for energy, metals, and agriculture results in a higher CPI. While inflation is generally bad for fixed income and can have an adverse impact on stock prices as well, the conventional wisdom is that this phenomenon is a big positive for positions in commodities [see also Invest Like Jim Rogers With These Three Agriculture Stocks].
It is important to understand, however, that not all individual commodities are equally effective as inflation hedges. Some exhibit a very strong correlation with indications of rising prices such as the consumer price index (CPI), while others are not nearly as effective. That means that for investors concerned primarily with protecting their portfolios from the ravages of inflation, picking the right commodity (or commodities) is a key consideration.
A detailed study on the effectiveness of various commodities presents some interesting conclusions; this piece is certainly a key resource for those looking to use commodities as an inflation hedge.

10. Thou Shalt Not Neglect A Position

Though estimates vary, as many as 90% to 95% of commodity investors report losses from their trading activities. Commodities are volatile, difficult to predict, and as such, can be extremely frustrating investments. But one sure way to lose money is to simply neglect a position. While it seems fairly obvious that a lack of monitoring is a poor choice, the recent influx in commodity ETPs has made this asset class more readily accessible to those who may not be used to keeping a watchful eye on their positions [see also ].
A commodity position will typically be measured in hours and days rather than months and years. Prices can be extremely volatile with seemingly insignificant events having a major trickle-down effect on the underlying investment, so the need for active monitoring is vital to the commodity space. Note that this piece of advice is most applicable to futures-based investments; there are a select few physically-backed commodity ETPs as well as equity investments that can be used for longer term strategies. If you do not have the time to watch your position through out the day, you probably have no business making the investment in the first place. Other than VIX contracts, commodities can be some of the most volatile investments available today and investors need to proceed with caution [see also The Guide To The Biggest Companies In Every Major Commodity Sector].
On the flip side, actively monitoring will not only avoid losses, but it will typically lead to gains. Those who keep one ear to the ground so to speak, will have a much better chance of hopping in and out of trends intraday and turning a quick profit from the momentum of commodity markets. Commodity trading is meant to be volatile and for those who are unable to stomach the risk, it can be a brutal investing process. As a more general piece of advice, have a profit objective for each position and be willing to accept your losses when you were wrong. A sound and stable mind combined with good risk management will lead to smarter and more effective commodity trades.
[For more commodity ideas sign up for our free CommodityHQ newsletter]
Disclosure: No positions at time of writing.
Commodity HQ is not an investment advisor, and any content published by Commodity HQ does not constitute individual investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities or investment assets. Read the full disclaimer here.

Related News Stories



Tidak ada komentar:

Poskan Komentar