Ranking 2009’s Commodity ETPs

January 4, 2010

Its 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 lets 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 isnt 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. Anexchange-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 institutions debt, obliging the bank to adjust the notes 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 thats 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 trusts 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 trusts actual  net asset value and its share price. But its 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, its a timing issue. Most of the time, a considerable difference between the last sale price and a funds 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 products index methodology or the portfolios management.

Therell 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 funds manager may not be able to exactly replicate—in timing or size—the funds benchmark index. There are also transaction costs and expenses borne by the portfolio—commissions, bid/ask spreads, etc.—that arent 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 notes return, so there may be an apparent spread between the underlying commoditys spot return and that of the notes. By far, however, the most significant error between a notes 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, lets 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, well focus on a dozen single commodities, rather than sectors.