The JP Morgan XF Physical Copper Trust-a fund that is
currently in registration at the Securities and Exchange
Commission-would be the first ETF to be backed by physical
copper, much like the SPDR Gold Fund (NYSEArca:GLD) holds gold
bullion. But that's if the fund ever makes it to market,
especially now that a New York law firm filed a complaint with
U.S. regulators on behalf of a copper merchant and copper
fabricators, arguing that the copper trust would do more harm
than good to the overall copper market by making crucial supply
unavailable. U.S. Commodity Funds' Chief Investment Officer
John Hyland visited with IndexUniverse.com's Cinthia Murphy to
offer his perspective on what he says is a letter that shows how
little the opposition understands ETFs and prospectus language
instead of being able to actually identify real
threats. Hyland is the brains behind the U.S. Copper Index
Fund (NYSEArca:CPER), the first futures-based copper portfolio,
which his firm made available to U.S. investors in November.
The complaint in the letter was that the JP Morgan XF Physical
Copper Trust would remove from the market as much as 30 percent of
the copper available for immediate delivery worldwide, which would
push prices up and "disrupt" the normal flow of copper trading by
causing an artificial squeeze. Is that a fair assessment?
That part of the SEC comment letter is just a scare tactic. You and
I both know that how many shares an ETF registers for in their
prospectus has zero to do with how many shares the fund and assets
under management the fund will have when it launches. JP Morgan's
most recent prospectus shows them registering 6.18 million shares.
When I register funds, I often register anywhere between 50
million and 1 billion shares. The number really reflects how many
shares the fund
issue over its lifetime, or at least over the first few years, and
not the size on day one or the maximum number of shares outstanding
at its peak. When, or if, this fund launches, it will start with no
fewer than 100,000 shares worth $7 million [100,000 shares is the
NYSE minimum to list], and maybe a maximum of 500,000 shares, worth
maybe $35 million.
Note that if an ETF that is a 1933 Act fund registers 50 million
shares, and then has an initial wave of creations of 4 million, it
now has 46 million unissued left. But if it redeems 2 million
shares each month over each of the next 12 months, and creates 2
million more later in the same month, it will end the year still
with 4 million shares outstanding, but now with only 22 million
unissued shares remaining. So an ETF always needs to register a lot
more shares than it ever has outstanding at any one time.
Will this fund receive massive amounts of inflows that will cause
physical holdings of copper to shoot upward?
I doubt it. Copper is not gold, and few, if any, investors feel a
compulsion to own it in the physical form unless a compelling
financial opportunity arises.
Since this fund will earn you the spot movement of copper minus
fund costs and minus what are likely to be hefty storage
costs-maybe 3 percent annual combined expense-it is not clear that
people will flock to this fund unless copper futures are in steep
contango. I think it will have a certain user base, but I doubt it
becomes a big fund. Copper futures are most of the time easier and
cheaper to use to invest.
Will a physical copper fund have a predictable impact on the spot
price of copper? Could it cause it to automatically go higher?
Anybody who tells you that has no real evidence for their opinion.
I can give you reasons why it could cause prices to trend a bit
higher, if the fund was large, but I can also give you reasons why
it could cause copper prices to go lower.
A lot of it will depend on not only the size of the fund, but on
how its exact creation/redemption procedures will work in practice.
Remember, at any given time there are hundreds of thousands of tons
in LME warehouses anyway. There are millions of tons worldwide in
It is not clear that the copper owned by this fund, that must
'sell it' to anybody who wants to do a redemption on any given day,
will automatically push the price up-as opposed to if the exact
same copper was owned by Glencore or General Electric, kept in the
exact same warehouse, but only sold when Glencore or GE felt like
My best guess is that most likely it will have little or no
effect on spot copper prices.
Notwithstanding the fact that the NYSE has filed a 19b-4 on this
fund, is it actually anywhere near being close to launch?
I don't think so. The most recent updated draft prospectus for this
fund was filed on July 12, 2011. That draft did
include minor details like the ticker symbol, the CUSIP number, or
any disclosure at all about the levels of fees and expenses. Until
J.P. Morgan files a draft that does include that info, assume this
thing is months and months away from launching.
Why do you think the firms who filed this comment letter have done
Do not automatically assume that they are concerned about the
integrity of the copper market. That could be true. It could be
that they just do not know how to read a prospectus or do not
understand how ETFs work.
However, putting on my cynical hat, it could also be the case
that they just do not want a transparent, public player that's
always willing to buy copper every day, at the market price via the
creation process, and always willing to sell physical copper every
day, at the market price via the redemption process, shining any
light on their little corner of the world.
The first rule of big players in any nonpublic market, like
physical copper, is to keep everybody else in the dark for your own
At its heart, GLD-the physical gold ETF-is not really a fund. It
is a highly public gold-bullion-trading platform.
The same would be true of a large physical copper ETF. That may
be good for the copper market in general, while at the same time
being bad for certain large players who like being able to dominate
a market. Their motives may be much less pure than their comment
letter would suggest.
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