Leveraged Vehicles For Commodity Investing

Leveraged Vehicles for Commodity Investment and Speculation By Dirk Masuch Oesterreich Contact: www.servicioshidrogis.com, http://nevadagoldinvestor.blogspot.com, [email protected]

The ongoing bull market in commodities sparked a whole new category of investment vehicles designed to follow or even leverage the price performance of the underlying commodity or sector stocks. These new instruments come along as Exchange Traded Funds (ETF) and Exchange Traded Notes (ETN). The concept of ETF’s of course is nothing new. The NASDAQ PowerShares QQQQ has been around quite a while. The fund has been wildly successful as an instrument for investment and speculation. It was only a matter of time before similarly structured funds would be available for commodities investors. Among the first of the new commodity ETF’s was the Gold Shares SPDR (GLD). The fund aims at tracking the price performance of gold bullion. The iShares Silver Trust (SLV) is designed to do the same for silver. The US Oil Fund ETF (USO) tracks the price of West Texas Intermediate Crude. I don’t want to go into discussions whether GLD and SLV, at any given moment, do or do not hold all the bullion they claim to hold. Neither do I intend to discuss the specific details of any of the instruments that follow below. Like always, you should do your own research of the funds that may appeal to you. Having said that, imagine you were invested in the US Oil Fund USO for the last 12 months or so. Returns on that particular investment were just short of amazing. Now imagine you leveraged your bets with options. And on top of that, you find out that there are leveraged investment vehicles that roughly double the commodity’s price performance. And some of these instruments even provide options trade. There are funds and notes that trade to the long side and there are those that trade to the short side. There are long, short, double long, and double short exchange traded funds and notes on almost every commodity and sector stocks. Now before diving head on into the world of highly leveraged commodities speculation, consider that these vehicles work in both directions. Make your best effort to ensure you are trading in the right direction. Otherwise it will feel like the wrath of Khan is upon you – you will lose money very fast. A few examples will illustrate the tools investors and speculators now have in their box. Suppose you are of the opinion that high prices for corn and food for livestock will have to work their way into meat prices. The DJ Livestock ETN (COW) may be the vehicle to act on that opinion. On the other hand there is AGA, a two times leveraged short ETN on the price performance of the agricultural sector. The US Gasoline Fund (UGA) would be interesting for those who think that gasoline prices in the US still do not reflect the reality of $140 oil, or even $100 oil. For the adventurously inclined, a bet on UGA can even be leveraged by options. The Merryl Lynch Oil Services Holders ETF (OIH) is a basket of stocks from the oil and oilfield services industry. Companies like Schlumberger, Halliburton, Baker Hughes, and Diamond Offshore Drilling comprise large parts of this ETF´s holdings. Two brand new vehicles, PowerShares Crude Double Long (DXO) and PowerShares Double Short (DTO) allow leveraged bets on the price of crude. The iShares US Exploration & Production ETF holds shares of companies like Occidental Petroleum, Devon Energy, Chesapeake Energy, and Anadarko Petroleum. The PowerShares Dynamic Exploration and Production ETF is similarly structured and offers the leverage of options trading.

The precious metals complex also offers leveraged trading vehicles on their price performance. While GLD (gold) and SLV (silver) are already well established, the new ETNs DGP and DZZ offer a double long or a double short leverage. DGP may be interesting at the beginning of a new gold upswing while DZZ could be a vehicle for timing a correction. Just remember, buying into neither of these instruments entitles you to physically hold gold or silver bullion. GLD and SLV even have to occasionally buy and sell bullion to achieve their stated goal to keep track of the bullion price. In this context an often overlooked fund may offer a conservative investor more peace of mind than the funds mentioned above. The Central Fund of Canada (CEF) is a very conservatively managed and strictly audited fund that holds securely vaulted gold and silver bullion. It does not engage in market actions to adjust its holdings for price performance since it does not intend to track the bullion price. However, the fund occasionally adds to its holdings. It does so by offering a number of new shares in line with the value of the added bullion so that dilution is not an issue. Metal in CEF’s property basically sits in a Canadian bank vault and defines the fund’s Net Asset Value around which the share price of the fund fluctuates. The clean tech / alternative energy sectors also provide a wide diversification of funds and ETNs. TAN and KWT are globally diversified vehicles of investing in the solar energy sector. Both of them offer options trading for leverage. If you subscribe to the fear of a global water crisis, several instruments are available for investing in the water industry as well as the clean tech sector. Nuclear energy these days is making a comeback as a reliable energy source. The Market Vectors Nuclear Energy ETF and the PowerShares Global Nuclear Energy ETF offer participation in this trend. They invest in energy providers like German giant E.ON and global industrial conglomerates like Toshiba. NLR also holds shares of uranium miners Cameco and Uranium One. Last but not least, the Market Vectors Coal ETF (KOL) is a simple way to participate in the growing bull market in coal. While surely not counting as clean energy coal is still the major energy source worldwide. Reserves are plenty and there is no “Peak Coal” in sight. In times of Peak Oil and ever rising oil prices coal is again gaining traction as the most reliable source of energy. Options of KOL can be traded for leverage. The effect of these new instruments on commodity markets will probably be increased price volatility. They may also divert capital into funds that would otherwise be invested in shares of commodity producers and explorers. This has surely been the case with the junior mining sector, especially the exploration companies. Their performance over the last two years or so has been nothing but frustrating. The big miners as indexed by the HUI also seem to have lost their former leverage factor to the gold price. It may well be that they lost a great amount of shareholder capital to GLD and SLV. I don’t know if this is a good thing or a bad thing. As an investor you probably don’t care too much as long as the long term trend of your investment doesn’t break while a trigger happy speculator will probably be delighted by the new trading tools he now has in his arsenal. In any case prepare for more interesting times to come. Are there risks associated with these exchange traded funds and notes? Plenty. Each of these vehicles has its own specific risk related to the underlying commodities or the performance of their sector stocks. There is, however, an additional specific risk to consider. It is the risk related to the bank issuing these instruments. In today’s environment, this has to be a serious consideration. There is no use in being right in the choice of your ETF/ETN when the issuing bank is at risk of going out of business. Holding an ETF or an ETN is holding a paper promise. It is not clear how an investor holding a certain ETN would be made whole in the case of a bank default. The following list is far from complete and may contain errors.

SYMBOL

NAME

OPTIONS

LONG / SHORT

AGRICULTURE COW MOO DBA AGF DAG ADZ AGA

iPath DJ AIG Livestock ETN Market Vectors Agribusiness ETF DB Powershares Agriculture DB Agriculture long ETN DB Agriculture double long ETN DB Agriculture short ETN DB Agriculture double short ETN

X X

1x long 1x long 1x long 1x long 2x long 1x short 2x short

OIL OR GAS USO UGA UHN UNG DBO OIH FCG OLO DXO SZO DTO

US Oil Fund US Gasoline Fund US Heating Oil US Natural Gas Power Shares DB Oil Fund Merril Lynch Oil Services Holders First Trust ISE-Revere Natural Gas DB Powershares Crude long DB Powershares Crude double long DB Powershares Crude short DB Powershares Crude double short

X X X X X X

1x long 1x long 1x long 1x long 1x long 1x long 1x long 1x long 2x long 1x short 2x short

OIL AND GAS IEO XOP DIG DUG

Ishares Dow Jones US Exploration & Production Spiders Oil & Gas Exploration & Production Ultra Oil & Gas ProShares Ultra Short Oil & Gas

X X X

1x long 1x long 2x long 2x short

ENERGY (GENERAL) IXC IYE XLE DBE ENY PXE

iShares S&P Gobal Energy iShares Dow Jones US Energy Energy Select Sector SPDR PowerShares DB Energy Claymore/SWM Canadian Energy Income PowerShares Dynamic Exploration & Production

X X X X X

1x long 1x long 1x long 1x long 1x long 1x long

GOLD AND SILVER ETF & ETN GLD DGP DGZ DZZ SLV

Gold Shares SPDR DB Gold Double Long ETN DB Gold Short ETN DB Gold Double Short ETN iShares Silver Trust

X

1x long 2x long 1x short 2x short 1x long

X X X X X X

1x long 1x long 1x long 1x long 1x long 1x long 1x long 1x long 1x long

ALTERNATIVE ENERGY TAN KWT CGW PIO FIW PHO GEX PBD PBW

Claymore/MAC Global Solar Energy Market Vectors Solar Energy ETF Claymore S&P Global Water Power Shares Global Water First Trust ISE Water Power Shares Water Resource Market Vectores Global Alternative Energy ETF Power Shares Global Clean Energy Power Shares Wilderhill Clean Energy

X

NUCLEAR ENERGY NLR PKN

1x long 1x long

Market Vectors Nuclear Energy ETF PowerShares Global Nuclear Energy COAL

KOL

Market Vectors Coal ETF

X

1x long