HardAssetsInvestor

Written by Brad Zigler  |

December 31, 2009

Ranking 2009’s Commodity ETPs

Details

As we head toward 2010, we take one last look back at the year's best-performing commodities—and its worst.

• Why do returns between ETFs, ETNs and trusts differ?
• Rankings of 12 different commodities
• What a difference contango makes

 

It's that time of year again: time to look back upon the now-ebbing 2009 and assess its best and worst performers.

All in all, it was actually a pretty good year for commodities. Better for some, certainly, than for others, but let's not forget that the preceding year was an especially rough one for commodity investors.

Note that I said investors, not traders. The buy-and-hold approach to commodities in 2009 was a bit of a mixed bag. Buy-and-hold isn't something most commodity account holders can reasonably do, given the margins employed in futures trading, although long-term holds are possible for investors in grantor trusts, exchange-traded funds and exchange-traded notes.

(A quick refresher on the different structures: A grantor trust is a custody account into which an asset, such as precious metal, is deposited; pro-rata shares in the account are then sold to investors as limited partnership interests. An exchange-traded fund (ETF) is a portfolio of securities or futures held for the benefit of shareholders, akin to a mutual fund. An exchange-traded note (ETN) represents a financial institution's debt, obliging the bank to adjust the note's maturity value by the degree of change in a specified index.)

 

Trusts, Funds And Notes: Behind The Returns

With these different methods of "owning" commodities, there are bound to be differences in the returns engendered. By and large, grantor trusts will provide the closet thing to holding actual commodities, because that's in fact what the trust actually does: Physical assets are deposited, rather than futures or stocks. Differences between the return earned by the actual commodity and that of the interests in a grantor trust more than likely result from the trust's expenses (in the case of precious metals trusts, gold or silver is sold to finance storage, insurance and custodial fees).

In addition, there may be an apparent error between the trust's actual net asset value and its share price. But it's important to remember that transactions printed on the tape (or seen scrolling by on CNBC or Bloomberg TV) are "last sale" prices, not the current bid or ask. If the midpoint between the current bid and ask—refreshed at least every 15 seconds—is used as a reference point, the error is usually negligible.

For exchange-traded funds, however, tracking error can sometimes be significant. Largely, it's a timing issue. Most of the time, a considerable difference between the last sale price and a fund's end-of-day net asset value or its intraday indicative value can be attributed to a relative infrequency of trades in the security, although tracking error can also result from the product's index methodology or the portfolio's management.

There'll naturally be a difference between the return earned by a futures-based fund and a cash commodity, because futures' inherent pricing conventions ("contango" and "backwardation") produce incremental yields (negative and positive, respectively, for long-only portfolios). In addition, a fund's manager may not be able to exactly replicate—in timing or size—the fund's benchmark index. There are also transaction costs and expenses borne by the portfolio—commissions, bid/ask spreads, etc.—that aren't embedded in an index.

An exchange-traded note will not be subject to index tracking error, since there is no actual portfolio being managed. No portfolio means no frictional transaction costs. Contango or backwardation, however, will still be reflected in the note's return, so there may be an apparent spread between the underlying commodity's spot return and that of the notes. By far, however, the most significant error between a note's return and that of its underlying commodity comes back to liquidity; ETN turnover can often be quite small, so the last sale could be quite stale, especially for those tracking more volatile commodities.

 

The Good, The Bad And The Ugly

So what commodities did well in 2009—and which ones did not?

To answer that question, let's look at those commodities that offered investors and traders the greatest choice: the ones serving as a basis both for domestically traded futures and exchange-traded products. To make direct comparisons possible, we'll focus on a dozen single commodities, rather than sectors.