Investing in metals used to mean buying gold and silver
bullion, gold Krugerrands and maybe American Silver Eagles. No
longer: ETFs and ETNs offer easy access to both precious and base
metals: gold, silver and platinum, copper, nickel, tin, even
lead. These funds are compelling tools that have truly opened up
a new horizon for investors.
Precious and base metals often demonstrate very different
return and performance. Base metals tend to be highly cyclical
and perform like basic materials such as oil, chemicals, or wood
products. They tend to do well in a strong economy. Precious
metals tend to be more counter-cyclical: popular with investors
when things get tough, as a store of value in times of inflation
and fear. The chart below confirms this phenomenon; it compares
the chart of PowerShares DB Base Metals Fund ETF (NYSEArca:DBB),
which has exposure to copper, aluminum and zinc with PowerShares
DB Precious Metals Fund ETF (NYSEArca:DBP), which has exposure to
gold and silver:
As the chart shows, precious metals fund DBP and base metals
fund DBB parted ways in October 2008 as the financial crisis got
underway.
Metals funds use three distinct strategies: ownership of the
metal itself, ownership of futures contracts to buy the metal,
and the ownership of a note to track the price of the metal. No
strategy is perfect. All have advantages and disadvantages.
Investors should consider fund liquidity, tracking error,
counterparty risk, tax implications, and performance in times of
market stress.
A good example of the direct ownership strategy is GoldShares
(NYSEArca:GLD). The fund provides investors with advantages: a
sense of security and a clear and unwavering sense of what is
owned-- a physical commodity, a metal. Introduced in late 2004,
GLD is the most established metals fund, holding close to 20
billion dollars invested in gold bullion. GLD has a modest
expense ratio, 0.4% and competes with the iShares COMEX Gold
Trust (NYSEArca:IAU). The iShares Silver Trust (NYSEArca:SLV) is
similarly structured. It holds close to 4 billion dollars of
silver bullion. Like the gold held in GLD and IAU, the silver
owned by the SLV is the real stuff, bullion stored in the fund's
custodian's vault, in the main London branch of J.P. Morgan Chase
Bank.
Direct ownership of bullion is nice but has distinct
disadvantages: storage fees and tax consequences. Whereas the
long-term tax rate on stock is 15%, bullion trades are taxed by
the IRS at the collectibles rate of 28%. It may not seem fair
that the GLD and SLV look like stocks, trade like stocks and are
about as collectible as any other ticker on your computer screen,
but nonetheless are taxed so much higher. This is the consequence
of owning a share of physical bullion stored in a physical
vault.
An alternative to direct ownership of bullion is the ownership
through futures contracts to buy bullion. PowerShares has a line
of ETFs which take this tack. PowerShares DB Gold Fund ETF
(NYSEArca:DGL) PowerShares DB Silver Fund ETF (NYSEArca:DBS),
PowerShares DB Precious Metals Fund ETF (NYSEArca:DBP) (80% gold,
20% silver), PowerShares DB Base Metals Fund ETF (NYSEArca:DBB)
(holding contracts for copper, aluminum and zinc). Like other
commodity products, this family of PowerShares ETFs is structured
never to take delivery of the actual metal, so technically
speaking no metal is owned. Instead, these ETFs roll over the
contracts to buy the metal: before the contract comes due, the
fund sells that contract and buys another near term contract.
From a tax standpoint this can be an advantage to owning bullion
because futures contracts are taxed at a lower maximum rate of
23%.
But there are disadvantages associated with this kind of
ownership too. One problem for many investors is psychological: a
futures contract is not the same as owning "the real thing:"
there is no vault, no metal, only pieces of paper called futures
contracts. A second and potentially far more serious problem with
futures ownership will be familiar to ETF investors who follow
United States Oil (NYSEArca:USO), which holds futures contracts
on crude: the difficulty of accurately tracking the spot price.
All this complexity means that these ETFs are far less popular.
The market capitalization of the PowerShares funds put together
for example is just a fraction of SLV.
In addition to the PowerShares funds there are several ETFs
that use futures contracts to lever up, and increase metals
exposure. These attempt to return double the movement of gold and
silver and are available both the long and short side. These
funds are the ProShares Ultra Gold ETF (NYSEArca:UGL), ProShares
UltraShort Gold (NYSEArca:GLL), ProShares Ultra Silver
(NYSEArca:AGQ), and ProShares UltraShort Silver
(NYSEArca:ZSL).
A third general strategy involves exposure through notes or
ETNs (Exchange Traded Notes). Until the recent market melt-down,
the ETN was often thought to be a better mousetrap because its
structure avoids many of the problems of other strategies.
Because they are built to track an index and no securities
ownership is prescribed, ETNs can be more flexible. Even better:
ETNs are taxed at the same rate as stocks (15% for long term
holdings), which beats the other strategies.
But ETNs do have one problem that ETFs-- whether they hold the
metal itself or futures-- do not have: counterparty risk. ETNs
are effectively promises made by their issuer. They are unsecured
debt: promises to pay according to the performance of an index. A
bank failure (or the threat of a bank failure) can cause these
instruments to lose value independent of holdings, tracking error
and how well the underlying index is performing.
The most diversified of the metals ETNs is the ELEMENTS Rogers
International Commodity Metal ETN (NYSEArca:RJZ), which includes
both precious and base metals. RJZ emphasizes aluminum, copper
and gold but includes silver lead, zinc, platinum, nickel, etc.
E-TRACS UBS Bloomberg CMCI Industrial Metals ETN (NYSEArca:UBM)
provides exposure to five base metals, but is approximately 75%
in copper and aluminum with smaller ratios of zinc, nickel and
lead. The AIG Industrial Metals ETN (NYSEArca:JJM) is framed to
track futures contracts of four metals: aluminum, nickel, zinc,
and copper. MLCX Precious Metals ELEMENTS ETN (NYSEArca:PMY)
holds a mix of gold, silver, platinum and palladium.
And then there are the many ETNs that reflect sub-indexes:
iPath AIG Copper (NYSEArca: JJC), iPath DJ AIG Tin
(NYSEArca:JJT), iPath DJ AIG Lead (NYSEArca:LD), iPath DJ-AIG
Aluminum (NYSEArca:JJU), iPath DJ AIG Nickel (NYSEArca:JJN), and
the precious metals: E-TRACS UBS CMCI Gold (NYSE Arca:UBG), the
ELEMENTS MLCX Gold (NYSE Arca:GOE), E-TRACS UBS Bloomberg CMCI
Silver ETN (NYSEArca:USV), E-TRACS UBS Long Platinum ETN
(NYSEArca:PTM), and the iPath DJ AIG Platinum ETN
(NYSEArca:PGM).
The ETN structure easily accommodates a variety of leverage
and short strategies including the PowerShares DB Base Metals
Double Long ETN (NYSEArca:BDD), PowerShares DB Base Metals Double
Shrt ETN (NYSEArca:BOM), the PowerShares DB Base Metals Short ETN
(NYSEArca:BOS), PowerShares DB Gold Double Long ETN
(NYSEArca:DGP), PowerShares DB Gold Double Short ETN
(NYSEArca:DZZ), PowerShares DB Gold Short ETN (NYSEArca:DGZ), and
E-TRACS UBS Short Platinum ETN (NYSEArca:PTD). Leverage and short
strategies of course involve additional risk.
Metals funds and expense ratios are listed below:
Bullion Ownership
Bullion Ownership
SPDR GoldShares (
GLD
), 0.4%
iShares COMEX Gold Trust (
IAU
), 0.4%
iShares Silver Trust (
SLV
), 0.5%
Futures Based
Futures Based
PowerShares DB Precious Metals Fund ETF (
DBP
), 0.75%
PowerShares DB Base Metals Fund ETF (
DBB
), 0.75%
PowerShares DB Gold Fund ETF (
DGL
), 0.75%
PowerShares DB Silver Fund ETF (
DBS
), 0.75%
Short/Leverage
Short/Leverage
Ultra Gold ETF (
UGL
), 0.95%
ProShares UltraShort Gold (
GLL
), 0.95%
ProShares Ultra Silver (
AGQ
), 0.95%
ProShares UltraShort Silver (
ZSL
), 0.95%
Exchange Traded Notes
Exchange Traded Notes
Diversified
Diversified
ELEMENTS Rogers International Commodity Metal ETN (
RJZ
), 0.75%
E-TRACS UBS Bloomberg CMCI Industrial Metals ETN (
UBM
), 0.65%
iPath DJ AIG Industrial Metals ETN (
JJM
), 0.75%
ELEMENTS MLCX Precious Metals ELEMENTS ETN (
PMY
), 0.75%
PowerShares DB Base Metals Long ETN (
BDG
), 0.75%
Sub-Index
Sub-Index
iPath AIG Copper (
JJC
), 0.75%
iPath DJ AIG Tin (
JJT
), 0.75%
iPath DJ AIG Lead (
LD
), 0.75%
iPath DJ-AIG Aluminum (
JJU
), 0.75%
iPath DJ AIG Nickel (
JJN
), 0.75%
E-TRACS UBS CMCI Gold (
UBG
), 0.65%
ELEMENTS MLCX Gold (
GOE
), 0.38%
E-TRACS UBS Silver (
USV
), 0.65%
E-TRACS UBS Platinum (
PTM
), 0.65%
iPath DJ AIG Platinum (
PGM
), 0.75%
Short/Leverage
Short/Leverage
PowerShares DB Gold Short ETN (
DGZ
), 0.75%
E-TRACS UBS Short Platinum ETN (
PTD
), 0.65%
PowerShares DB Base Metals Double Long ETN (
BDD
), 0.75%
PowerShares DB Base Metals Double Short ETN (
BOM
), 0.75%
PowerShares DB Base Metals Short ETN (
BOS
), 0.75%
PowerShares DB Gold Double Long ETN (
DGP
), 0.75%
PowerShares DB Gold Double Short ETN (
DZZ
), 0.75%
Jonathan
Bernstein
has been writing about ETFs since 2003 and is the author of
Sector Trading: A Year in Exchange Traded
Funds
.
Jonathan
Bernstein
has been writing about ETFs since 2003 and is the author of
Sector Trading: A Year in Exchange Traded
Funds
.
Jonathan
Bernstein
Sector Trading: A Year in Exchange Traded
Funds