Commodity ETPs -- they're all an oil play

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Commodity ETPs -- they're all an oil play

Postby Browser » Thu Dec 27, 2012 11:22 am

I was looking at the most popular commodity ETFs and ETNs, and I was surprised to find that all of them seem to essentially be proxies for investing in crude oil futures, regardless of their purported diversification across different types of commodities. Over the past 5 years, here are the average 30-day correlations with OIL, which is the iPath crude oil futures tracking ETN:

______Energy Wt.______OIL corr.
DBC.......56%..............0.88
DJP.......31%..............0.82
GSG.......68%..............0.96
RJI........44%..............0.89

GSG is the least diversified product, having 2/3 of it's weighting in energy; while DJP is the most diversified with only about 1/3 in energy. Yet there is only a small difference in the return correlation between these two products and crude oil futures. Seems to me it doesn't make any practical difference which of these is held, since they all essentially represent an investment in crude oil futures. The decision to invest in any of them should be driven by the desirability of investing in oil futures and the diversification benefit to one's total portfolio therefrom. Beyond that, the one with the lowest expense ratio might be preferable.
If we have data, let’s look at data. If all we have are opinions, let’s go with mine. – Jim Barksdale
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Re: Commodity ETPs -- they're all an oil play

Postby larryswedroe » Thu Dec 27, 2012 11:51 am

Browser
I strongly disagree. It makes a huge difference
First, with commodities that are easily storable, like gold, the futures prices are basically a pure arbitrage considering interest rates, insurance and storage costs (the cost of carry). So they will always been in contango, but one that really doesn't cost much because you earn the interest rate back, or higher, on the collateral. But with not easily storable commodities, like oil, you can have big contango or backwardation. So when you have big increase in demand for hedging you drive futures prices up--bigger contango. And that appears to be what is behind the increased contango in oil futures. But it doesn't impact the easily storable commodities like gold. Just check out the various futures contracts--WSJ for example has them daily.

Second, the above shows up in differences in returns which can be as much as 20% a year between the S&P/GSCI and DJ-UBS. Personally I prefer the DJ-UBS because it is more broader based and thus more likely IMO to reflect overall inflation and also for the contango issue (at least in last few years) I mentioned above.

I hope that helps

Best wishes
Larry
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Re: Commodity ETPs -- they're all an oil play

Postby Browser » Thu Dec 27, 2012 12:27 pm

Larry - I'm just saying that it is the returns from oil futures that largely drives all of these popular "diversfied" commodity ETPs - that's evident from the correlations. Diversification is not proportional to the weighting in energy, since GSG and DJP have similar correlations to oil futures returns despite the fact that GSG has twice the weighting in energy. And the correlations between them are enormously high (.9s). If you think you're getting diversified commodity exposure with these vehicles, then think again. If you really want diversified exposure then you need to invest in separate single-commodity ETPs. Otherwise, six of one = half dozen of the other, IMO.
If we have data, let’s look at data. If all we have are opinions, let’s go with mine. – Jim Barksdale
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Re: Commodity ETPs -- they're all an oil play

Postby larryswedroe » Thu Dec 27, 2012 1:15 pm

Browser
Correlations are not everything, you can have massive differences in returns. Like I said as much as 20% a year. And you have the higher costs of hedging oil due to current hedging demand in not easily storable commodity-oil/natural gas.
Best wishes
Larry
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