Countless investors have been baffled about how their natural
gas ETF could have lost so much money while the spot prices of
natural gas rose.
Weâve told the contango story before, but it canât be told
often enough. For most commodities, itâs impossible to actually
invest in the spot price. After all, it is simply impractical for
an ETF to hold physical natural gas or the countless bales of wheat
it would take to satisfy investor interest. Thus, investors buy
futures contracts or, these days, ETFs that are based on
Futures-based ETFs work by selling off old futures contracts as
they get close to expiration and buying new ones. If the new
contracts are more expensive than the old ones, thatâs called
contango, which costs you money. If the new contracts are less
expensive, you make money. If youâre curious about whether your
commodity of choice is currently in contango, check out our
affiliateâs weekly Contango Watch.
That said, if youâre interested in precious metals, there are
both physical and futures-based options. Unsurprisingly, the
difference can be pretty significant.
Iâve compared the physically backed SPDR Gold Shares
(NYSEArca:GLD) to the futures-based PowerShares DB Gold Fund
(NYSEArca:DGL). DGL tracks the DBIQ Optimum Yield Gold Index Excess
Return Index, which attempts to maximize roll yield.
While an index that tries to optimize roll yield is better than
one that simply rolls into the next monthâs futures contract,
gold is firmly in contango these days, so investors will lose some
of their returns regardless of whether DB chooses the near-month
contract or a contract that is three months out.
The returns since DGLâs inception confirm this pointâGLD has
outperformed DGL by nearly 20 percent since January 2007.
Itâs the same story in platinum. I compared the ETFS Physical
Platinum ETF (NYSEArca:PPLT) to the iPath DJ-UBS Platinum Subindex
Total Return ETN (NYSEArca:PGM). Depending on your start date,
youâll either see a big gap or an indiscernible gap between the
two funds, with contango being the driving force. The chart from
January 2010 through today shows the impact of contango quite
The futures-based funds arenât necessarily bad funds, they
just happen to be based on commodities that are currently in
contango. Were the commodities to go into backwardationâwhen
prices on the futures curve grow cheaper over timeâthe
futures-based funds would outperform their physical
Market volatility isnât going away anytime soon, and precious
metals have fallen from their August highs, so it may not be a bad
time to get back into precious metals. Whether that means a
physical or a futures-based fund is up to you.
Don't forget to check IndexUniverse.com's ETF Data
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