HardAssetsInvestor

Written by Brad Zigler  |

February 20, 2009

Commodities And Commodity Stocks Are Different. Sorta.

Details

HardAssetsInvestor.com's managing editor offers a simple way to measure the performance of commodities versus commodities stocks.

• Commodities and commodity stocks behave differently
• A look at the HAP/GCC ratio
• Correlations remain high

 

We spend a fair amount of ink, um, electrons, writing about gold and gold mining stocks (most recently in “Whither Gold Stocks?”).

At certain times, bullion, represented by the SPDR Gold Shares Trust (NYSE Arca: GLD) fares better than miners proxied by the Market Vectors Gold Miners ETF (NYSE Arca: GDX); at other times, the reverse is true. The GLD/GDX ratio reflects the relative strength of gold over mining shares.

There will be times, too, when a broader-based portfolio of commodities will outperform a universe of commodity stocks. I say will because we’re still in the very early stages of tracking an analogue to the GLD/GDX ratio. The Market Vectors RVE Hard Asset Producers ETF (NYSE Arca: HAP), a portfolio of nearly 300 commodity producers or processors, when compared to the GreenHaven Continuous Commodity Index ETF (NYSE Arca: GCC), meters the vigor of hard asset equity investment.

The HAP portfolio is consumption-weighted by sectors, allocating 39% to energy companies, 33% to agricultural firms and 21% to metals producers. The GCC fund is based upon a benchmark originally known as the Commodity Research Bureau Index. GCC’s portfolio comprises 17 equally weighted futures positions. By sector, the portfolio commits 18% to energy, 59% to agriculturals and 24% to metals.

HAP is relatively young, so its real world price history is short. Right now, HAP and GCC are trading near parity. In other words, the price ratio is wobbling around 1-to-1 as both portfolios’ shares trade in the $20-to-$22 range. If past history is any guide, there’s maneuvering room for the ratio, though. The somewhat older GCC portfolio traded as high as $38 in July 2008. That, and the fact that HAP’s volatility is double GCC’s, portends as much ratio variance as you’d find in the GLD/GDX spread.
 

Hard Assets Producers (HAP) vs. Continuous Commodity Index (GCC)

 

An increase in the ratio’s value heralds the ascendance of commodity stocks and therefore signals buying momentum for HAP. Declines in the ratio, on the other hand, indicate growing favor for commodities themselves and, in turn, the GCC fund.

So far, the HAP fund has proven itself to be the more volatile asset. That shouldn’t be surprising given the influence a commodity’s market price can have on company earnings. Price movement above a commodity’s production or processing cost goes straight to a firm’s bottom line. Those flows can be highly leveraged, too.

Margin improvement, real or anticipated, can significantly influence market value. Shares are valued on the basis of a commodity’s current price as well as expectations six to 18 months out.

With that, there’s still a fair degree of correlation between commodity price movements and producers’ stock values. The correlation between HAP and GCC is 65% to date. Given the diverse mix of commodities in each portfolio, that’s remarkable. After all, the correlation between the single-commodity GLD and GDX products is 75%.

Excursions beyond one standard deviation (1.10 on the upside and 1.00 on the downside) for the HAP/GCC ratio have been short-lived so far and generally have signaled hasty retreats into the fraction’s trading range. That’s likely to change as bottoming action unfolds in the petroleum and agricultural complexes, the two largest sectors represented in the HAP portfolio. Crude oil’s weakness has been a weighty drag on HAP‘s performance since inception.

 

 

Performance (11-Nov-08 through 19-Feb-09)

 

We’ll be monitoring the HAP/GCC at Hard Assets Investor over the coming months to provide clues to commodity investment sentiment and momentum, so stay tuned.