United States Commodity Funds, the firm behind the $1 billion United States Oil Fund, today rolled out a copper ETF based on Comex copper futures that’s designed to protect investors from the ravages of contango.
The United States Copper Index Fund (NYSEArca: CPER) is the first ETF to target the copper market, though it does join the $4.63 million iPath Pure Beta Copper ETN (NYSEArca: CUPM), which also focuses on copper futures. Both securities are designed to protect investors from contango, a condition in futures markets that can badly hurt investment returns over time.
Contango is when the soonest-to-expire contract is less expensive than contracts that expire in later months. That means a fund manager, in maintaining investment exposure, has to pay a premium to the price of the expiring contract when buying a new contract. Backwardation is the opposite, which means fund managers make money each time they roll into a contract that’s cheaper than the expiring one they are replacing.
Until this year, the copper market was on a tear, with demand from emerging market countries such as China fueling a nearly sixfold increase in price over the preceding decade. But copper prices corrected more than 20 percent downward this year, as China, which currently consumes 40 percent of the world’s copper supply, struggles to bring inflationary pressures under control and the developed world continues its slow slog out of the worst economic downturn since the 1930s.
Funds trading in copper futures have been hammered. iPath’s CUPM has fallen 19.12 percent in the past six months according to data on Google Finance, while the $148.3 million Dow Jones-UBS Copper Total Return ETN (NYSEArca: JJC), a first-generation ETN that holds only the soonest-to-expire contract, is down by 14.4 percent.
However, United States Commodity Funds’ Chief Investment Officer John Hyland told IndexUniverse in a telephone interview that he’s betting demand will eventually resume from developing countries and that the upward trajectory of prices is likely to resume.
The Contango-Killing Formula
According to the CPER prospectus, the fund’s holdings are based on an assessment at the end of each month as to whether the copper futures market is in contango or backwardation.
If the market is in backwardation, the fund’s index calls for:
- Taking positions in the two eligible copper contracts with the highest annualized percentage price difference, with each weighted at 50 percent of the portfolio
If the market is in contango, the fund’s index calls for taking positions in three copper contracts, as follows:
- The two eligible contracts with the higher annualized percentage price differences, with each contract weighted at 25 percent of the portfolio
- Another position in the nearest-to-maturity December eligible contract that has an expiration date more distant than the fourth-nearest eligible contract. That third contract would make up 50 percent of the portfolio, according to the fund’s prospectus.
The iPath ETN deals with the contango challenge with an index that allows for rolling exposure to an eligible contract with a view to choosing the one that minimizes the “negative roll” yield, or contango. The ETN also allows for exposure to two contracts during the roll period, according to information posted on iPath’s website.
U.S. Commodity Funds’ copper fund, CPER, comes with a 0.95 percent annual expense ratio, compared with 0.70 percent for the iPath ETN, CUPM.
Before long, CPER and CUPM won’t be alone in competing for investment dollars in the copper market.
That’s because both iShares and J.P. Morgan have physical copper ETFs in registration at the SEC. Unlike investing in futures via an ETF like CPER or an ETN like CUPM, these funds would also hold physical copper supplies in warehouses, offering investors the rough equivalent to spot prices.
Hyland argued that owning copper futures has significant advantages over owning physical copper because the cost of storing copper can be as much as 3 percent a year, which can significantly drive up the expense ratio of a fund.
He also argued that as an ETF trading in copper futures, his fund has advantages over the copper future ETNs.
“Americans don’t like ETNs,” Hyland said. “There are few ways that you could lose all of your money overnight in an ETF, but with an ETN, the bank could go belly up.”
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