HardAssetsInvestor

Written by Brad Zigler  |

July 01, 2010

The Second Quarter’s Best And Worst Commodities

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Which commodity (and its associated ETP) performed the best? (Hint: It wasn't gold.) Which performed the worst? We run the numbers to find out.

Quick! Name the best-performing single-commodity exchange-traded product (ETP) of the second quarter.

No, it's not a gold trust; the SPDR Gold Trust (NYSE Arca: GLD) came in third. It's actually the exchange-traded note tracking coffee's price, the iPath DJ-UBS Coffee Subindex Total Return ETN (NYSE Arca: JO).

Surprised?

Well, the second quarter was full of surprises for commodity investors. Unfortunately, most of them were unpleasant.

Of 17 single-commodity or narrowly focused products, only four turned a profit. The winners netted an average 12.1 percent gain, while the average loser gave up 9.9 percent.

We sought out the most liquid single-commodity ETPs to see how well they tracked the spot market over the last three months. When we couldn't find single-commodity ETPs to represent a sector of the futures market, we used the narrowest instruments; that is, two or three commodities wide.

Overall, ETPs—based upon their last sale prices—did a fair job of tracking spot market commodities. The average apparent return for the 17 ETPs was -4.7 percent, while the contemporaneous mean return for the underlying spot commodities was -2.7 percent.

But let's run the numbers asset by asset.

Precious Metals

Key: TST = Grantor Trust; ETN = Exchange-Traded Note

Gold and silver grantor trusts topped the precious metals group in the second quarter, partly because the trusts hold metal and aren't based upon a futures index. Of course, the underlying commodities increased over the period, but the product didn't get in the way of the gain's realization.

In a normal futures market, carrying charges—financing costs, storage charges and insurance fees—build up along the futures term structure to make contracts for deferred delivery more expensive than futures for near-term delivery. This condition, often referred to as contango, is expected when there's ample supply of a storable commodity.

An inverted market, on the other hand, exists when deferred deliveries are priced below nearby ones. A dearth of storable supply is usually the culprit.

Normal markets are costly for holders of ETPs based upon long-only futures indexes. In order to maintain exposure to the commodity, futures positions must be rolled forward as contracts approach expiry. In a normal market, that means higher-priced contracts will be purchased with the proceeds from lower-priced futures sales. This incremental loss—or negative roll yield—eats into returns.

That said, the slight disparity in the palladium trust's return vs. spot is a liquidity artifact. The last sale prices reported on the tape don't necessarily reflect the current markets for ETPs. The less actively an ETP trades, the greater the discrepancy between the last sale price and the current bid/offer spread.

This should be kept in mind when considering the apparent returns of light-volume exchange-traded notes.

Base Metals

Key: ETN = Exchange-Traded Note

The market for industrial metals was weak in the second quarter, reflecting the slackened demand for durable goods and housing. The apparent spread between the ETP returns and the spot market is, again, due to timing and contango.