August 23, 2010

Problem With Commodity ETFs

Businessweek recently ran an article about commodity ETFs.  They pointed out a problem with some ETFs that causes them to poorly track the underlying commodityy.   Their article which was creatively titled Amber Waves of Pain spells out how differences in future prices can eat away at ETF gains on commodities.  You can read the whole article for the specifics but the basic reason is that the ETFs lose take a loss every time they make certain futures trades on the market and these losses add up over the long run to greatly undercut the ETFs gains.  The Businessweek article concluded that you should not buy commodity ETFs at all because of this.  

We can compare the market price of the oil ETF versus the market price of crude oil.   For the ETF we'll use United States Oil Fund (USO) and the crude oil prices are online at the Dept. of Energy site.

Note: the cost of the crude oil doesn't include any of the carry costs of the oil.  If you owned actual crude oil then you would have to have facilities to store the oil and ship it and such which all costs money.  That could be a significant amount over time and would cut into any increases in the market prices.  

Lets say you decided to buy an oil ETF back in 2006.   If you bought USO when it first started trading in April 2006 you would have paid $68.82 on close of opening day.   Today USO is trading at $32.58.   Thats a loss of about 52.6% from your initial investment.   In the same timeframe the price of crude oil has actually gone up.  In April 2006 a barrel of crude was at about $62.99.    Today crude is trading at $76.77.   Thats an increase of about 21.8%.  

Change from April 2006 to August 2010
United States Oil ETF (USO) =  DOWN 52.6%
Crude Oil prices =  UP 21.8%

Yikes!   Thats horrible.   If you bought USO thinking that your investment would track the price of oil then its definitely not done so.

Lets look at the performance of raw crude oil prices versus the USO ETF since the start of 2009:

As you can see the raw crude prices went up around 80% and the ETF only went up about 20%.  

Not all ETFs are Equal

USO is only one of the ETFs that tracks oil.  Others include Powershares DB Oil (DBO) and iPath crude oil index (OIL).  Lets compare the 3 ETFs over time from the start of 2009.   I made the following chart on Yahoo finance:

Sorry if thats a little bit of an eye chart. The blue line is USO, red is DBO and OIL is in green.   In the time period shown, DBO is up about 15%, USO is down about 7% and OIL is down about 12%.   Thats a huge variation within just 1.5 year period between 3 ETFs that all track oil.

Depends on Structure of ETF

The USO ETF holds future contracts and is susceptible to the problem with trading futures.   Other ETFs may not have this kind of problem.   For example the SPDR Gold Shares (GLD) ETF trades in gold but does not use futures.  The GLD ETF actually buys and holds physical gold.  

Bottom Line:  If you're looking to buy a commodity via an ETF be aware that the ETF may not track the actual commodities gains very well.   Each ETF is different  and some may perform better than others.

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