Exciting New Commodity ETFs May Come Up Short

By: David Fry | Fri, Oct 21, 2005
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Below is a commentary originally posted at www.etfdigest.com on 23rd June 2005.

Every investor knows it's important to diversify their portfolios. However, just diversifying into various market sectors that trend in the same direction doesn't accomplish very much. Doing so may just add to transaction expenses and give investors a false sense of accomplishment.

Most knowledgeable investment professionals know that adding uncorrelated assets to an investment portfolio is more likely to accomplish true diversification, reduce risk and generate superior overall performance. New rumored and proposed commodity-based ETFs (silver, crude oil, and currency markets as well) are, for the most, part well-suited to achieve true diversification.

Most seasoned commodity traders are just as likely to be short a commodity as long. After all, we're dealing with commodities. Commodities market prices, and to a lesser extent bonds and stocks, are driven higher or lower purely by perceived and real supply/demand factors. Unlike stocks, commodities have no "earnings" or other similar fundamental issues that drive prices. Speculators and commercial hedging activities dominate whether for grains, energy, metals and so forth making for heavy two-way (long/short) activity.

Gold ETFs have been available for nearly a year and their issuance has been, and continues to be, well-received. Now an ETF for silver and crude oil (along with a rumored currency-based issue) are being proposed. This is potentially great news. Great, because adding these markets to a conventional investment portfolio can achieve true portfolio diversification. However, there's a big catch. If retail investors, like any typical commodity investor, are unable to short these commodity ETFs, then investors are deprived of the commodity diversification benefit - they can only be long or out.

Over the past two years, we've been discussing the difficulty retail investors have faced when trying to short most ETFs beneath the top half dozen or so issues. It's been a serious ETF short-coming that needs resolution especially if these new issues are released. (Read more about shorting ETFs)

Various ETF sponsors like to create these new issues when they perceive demand to be the strongest from a bullish perspective. This is understandable because they want a successful underwriting to earn fee income. Institutions are able to create new shares in increments of generally 100,000, (an amount well-beyond the typical retail investor's capacity) and then if they want, short. This suits sponsors because with each new share issued, they get more fee income. Retail investors are left to attempt shorting ETF shares that already exist in float. Sponsors have no financial incentive to assist them in this regard and most brokerage firm stock loan departments are appallingly unprepared.

Don't get me wrong, I'm very excited to have these issues available. They are the "missing link" that could allow mainstream investors the opportunity to achieve true portfolio diversification. However, I'm concerned that these new issues will have only a one-sided benefit. If retail investors are able to take advantage of all facets of commodity-based ETF investments, then the dream of individuals being able to create their own hedge fund can be realized. This would be a historic breakthrough.


 

David Fry

Author: David Fry

David Fry
ETF Digest

Dave Fry has devoted over 30 years to the business of trading and portfolio management. His registration as an arbitrator with both the National Association of Securities Dealers (NASD) and the National Futures Association (NFA) attests to his extensive experience and spotless compliance record.

Dave founded the ETF Digest in 2001 and was among the very first to see the need for a publication that provided individual investors with information and advice on ETF investing.

By 2002 ETF Digest trading programs were making triple-digit gains, despite the sharp overall market decline at that time, and Daves newsletter began attracting favorable coverage in Barrons, Forbes.com, and Wall Street Access.

Dave is a frequent commentator on ETFs and other issues important to individual investors, and his perspectives are featured in financial news sources such as CBS MarketWatch, Investor's Business Daily, Dow Jones Newswire, National Business Review, MSN Money, Yahoo! Finance, Bankrate.com, IndexUniverse.com, ETF Zone, and ETF Investor.

As the scope of ETF investing has expanded dramatically over the past few years, Dave has maintained a vital position as an investor advocate. He speaks out in favor of new ETFs to cover important market sectors and has seen new ETFs issued as a result. He is also very active in pointing out problems in the ETF marketplace to sponsors, issuers, brokers, and the media. Dave is committed to remaining at the forefront as this major investment trend continues to grow.

Some of the highlights of Dave's career before he launched ETF Digest include the following:

In 1999, he founded TechInvest Inc. and began sharing his expertise through the Internet in his TechTrend Advisor newsletter.

From 1997-99, he was Managing Director, Proprietary Investments, at JWH Investment Management (JWHIMI), an affiliated company of John W. Henry & Company. In that capacity, Dave was responsible for the management of private investments as well as some corporate accounts.

For a period of 10 years prior to joining JWHIMI, David owned and operated an NASD broker/dealer, Fry & Co., and an SEC registered investment advisory firm, Asia-Pacific Investment Management Inc. He was also a registered Commodity Pool Operator, Commodity Trading Advisor, and Introducing Broker.

Prior to operating his own investment firms, Dave was a Vice President, Investments, at Shearson Lehman Bros., and he held a similar position at Paine Webber.

During his tenure with registered firms he maintained the following licenses: Municipal Bond Principal (Series 53), Options Principal (Series 4), General Securities Principal (Series 24), General Securities (Series 7), Commodity (Series 3), State Securities License (Series 63), and State Insurance License (Life).

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