Raising the Red Flags on Commodity ETF’s.

Screaming headlines about the Russian and Ukrainian draughts and soaring prices have investors pouring into the new Tecrium Commodity Trust Corn exchange traded fund (CORN). But they may be serving themselves up a heap of trouble.

The July 26-August 1, 2010 print edition of  Business Week magazine put out a brilliant piece entitled “Amber Waves of Pain”  detailing how retail investors are getting fleeced when playing the agricultural and commodities ETF’s. The unwary are getting shredded by the contango, whereby far month futures contracts are trading at enormous premiums to the front month.

An entire sub industry of hedge funds has arisen to take advantage of this spread, at the expense of the ETF investor. Commodity ETF’s tend to own front month futures with huge premiums which quickly disappear, leading to a large underperformance relative to the underlying.

I have been highlighting these risk for the past year, and have done my utmost to steer readers away from the worst offenders (click here for “UNG is the Poster Boy for Everything that Can Go Wrong With an ETF” at http://www.madhedgefundtrader.com/march_5__2010.html ). The oil ETF (USO), has been similarly victimized, with Morgan Stanley now chartering tankers to take delivery of crude than Chevron. The problem persists in the agricultural commodities of corn (CORN), although to a much lesser extent.

Hedge funds in particular game the published “roll dates” when ETF’s shift positions from one month to the next. The only way to avoid this haircut is to trade short term and avoid the roll, deal directly in the futures, or only trade the physical commodity with an expectation to take delivery.

I have several friends who warehouse copper, and a London hedge fund recently accepted a huge quantity of cocoa (click here for “Hedge Fund Corners the Cocoa Market” at http://www.madhedgefundtrader.com/july-23-2010.html ).

Business Week, which was taken over by Bloomberg only a few months ago, is infamous in the investment world as the publication that ran its notorious “Death of Equities” cover in 1982. That was right at the absolute bottom of a two decade bear market, when the Dow was trading at the 600 handle. But they do raise some appropriate red flags here.

To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.

Comments

[Augustus]

One commodity related ETF that might be worth following the CRBQ.  It is made up of commodity producer shares.  The contango trade actually works in their favor.

[NoVolumeMeltup]

"Screaming headlines about the Russian and Ukrainian draughts"

Agreed. They can't brew beer worth a shit. Baltika is worse than some Canadian brands. Go with Belgian or Czech draughts if you have an option.

[Mr Lennon Hendrix]

ETFs are for losers.

[jdrose1985]

Tyler can we do away with this pole smoker please?

[lettuce]

while i don't necessarily concur with the terminology, i second the motion. i don't believe that we are seeing useful information here.

[Augustus]

Get more from the Matt Simmons, Dylan RatBrain, and Geo Wash.  Those really give some thoughtful pauses to consider "Is anyone really that stupid, and why the hell would they advertise it?"

[ATG]

Re MHFT bragging about warning about UNG in March 2010, UNG was around since 2007.

Re stating in the March MHFT You would think at first glance that this is a chart for an inverse gas ETF, which it isn’t, because such an instrument doesn’t exist, HND or SNGA inverse natural gas ETFs were around since at least Jan 2008.

Re contango issues with ETFs, they were published at least since 12 April 2006, and even noted by Mad Money Cramer last year.

http://www.smartmoney.com/investing/etfs/contango-and-cash-19323/

http://seekingalpha.com/article/129528-oil-etfs-cramer-discovers-contang...

Re MHFT MS boss BB, highlighted in that same March MHFT, BB was Bullish on Mexico in 1994 before the Peso default, and Bullish the S&P500 in 2008 before the Crash, having most recently bought the Market in early May 2010 after the top, and sold the market in July before the 9% rally.

http://en.wikipedia.org/wiki/Barton_Biggs

http://www.businessinsider.com/uber-bull-barton-biggs-throws-in-the-towe...

Oh well, prognosticating can be hazardous, particularly for those who follow blowhards in error.

For the sake of accuracy in media, personal integrity and reputation MHFT, how about doing your homework before spewing more self-serving off-the-cuff stale nonsense on ZH?

[furieus]

Who to believe.... MHFT today cautioning us against CORN, or MHFT on June 24th who wrote:

"The move comes on the heels of its successful launch of a corn ETF (CORN) earlier this month, the lead agricultural contract in the futures market. Teucrium plans to avoid the contangos that have bedeviled other commodity based ETF’s, like those for natural gas (UNG) (click here for my piece on its woes ), and crude (USO), by spreading investment over both front and far month contracts. ... Thank you Teucrium!"

http://www.madhedgefundtrader.com/june-24-2010.html

[ATG]

"I have several friends who warehouse copper, and a London hedge fund recently accepted a huge quantity of cocoa "

Exactly what is wrong with our economy MHFT.

Instead of doing productive business, these folks are hoarding.

Since we are in debt deflation, they may lose their capital for hiding their talents.

PS The Death of Equities BW Cover was 13 August 1979:

http://www.businessweek.com/investor/content/mar2009/pi20090310_263462.htm

The 25 April 2010 market top BW cover was Can GE Get its Juice Back?

[Flyingtrader]

Badhedgefundtrader,

This is a new low for you. You have done nothing but advertise these Ag ETF's, and NOW you have found religion? Where, pray tell have you highlighted any of the risks associated with the "contango" as you equites types like to call it?  I am incredulous that you would have the stones to come back and try to whitewash over your previous recommendations. (http://www.zerohedge.com/article/going-back-ags)

Contrary to your assertion that:

"An entire sub industry of hedge funds has arisen to take advantage of this spread, at the expense of the ETF investor. Commodity ETF’s tend to own front month futures with huge premiums which quickly disappear, leading to a large underperformance relative to the underlying."

I have been doing this for years. This is not a new game, it was born long before New York woke up one morning and decided that they knew how to trade ag futures by just getting long the front month; all the while ignoring the all important spread relationship between contract delivery months. 

A simple change of jargon could have saved many people a very expensive education.  Stop saying "contango" and start saying "carrying charges", because that's all the contango really is.  It reflects the cost of storing a physical commodity for the term between delivery months.  THIS IS FUTURES TRADING 101. 

All it takes to avoid getting fleeced is a greater understanding of the how's and why's of the spread trade.  It is sheer laziness on the part of the investor to assume that future contracts would perform like an equity and it is criminal that those that created and promoted (this includes you) the use of these products, did so without a greater understanding of the underlying product.