Tides Change As Investors Return To Commodities ETFs

December 05, 2008

Investors bought long and leveraged commodity ETFs in a big way in November. Has the sector turned the corner and found renewed popularity?


It has been a roller coaster year for commodities investors, but new information emerging from exchange-traded product sponsors indicates that the worst for the sector may be nearing its end.

Flows into long and leveraged commodities funds outpaced flows into short commodities products in November. That's the first time since the summer heights of the commodities boom that the trend has reversed itself.

"The high level of share outflows from earlier in the fall subsided in November. So even if we can't yet say with strong optimism that investors are coming back into commodities, the flows do indicate the end of the pessimism, though one still has to be cautious in this market," said Kevin Rich, managing director at Deutsche Bank.

He added: "The tide has turned a little in favor of net creations, even if prices have not been supportive."

Barclays Capital's commodities research team released a report on Dec. 4 showing that exchange-traded commodity products attracted about $700 million last month, with the majority going to energy-related investments. Energy products garnered $550 million and Precious Metals portfolios $230 million, the Barclays data showed.

The commodities-themed PowerShares DB exchange-traded notes had net inflow of $55 million in November, after two consecutive months of outflows from the ETNs. London-based ETF Securities experienced $185 million inflow to its commodities funds last week, its largest inflows in the past 19 weekly periods.

Most importantly, companies like ETF Securities and PowerShares DB that offer long, short and leveraged portfolios have seen the action tilt away from the short side toward the long and leveraged commodities exchange-traded products.

Tides Turn In November

Nick Brooks, head of research and investment strategy at ETF Securities, said there is evidence that investors are becoming more aggressive on the long and leveraged side of commodities.

The company's total assets peaked in July at $10.3 billion and declined to $6 billion through October, but over the past month flows have not just stabilized, but picked up.

"That pickup has been on the leveraged side and the strongest areas have been Oil and Energy. Investors may be heading back into the beaten-down asset class," Brooks said.

Last week, the bottom five ETF Securities portfolios as ranked by asset outflows were all short commodities funds.

Oil has been the single biggest component of the November tide turning in commodities, as tremendous interest in short oil ETFs in October reversed itself dramatically in November.

In November, Deutsche Bank had to register additional shares of the PowerShares DB Double Long Crude Oil (NYSEArca: DXO), because of the high level of flows, and the bank expects it will probably have to register more, Rich said.

He noted that all the action in the Sept.-Oct. period had been short and double short Oil, and those flows have now slowed noticeably.

ProShares, which just launched its first suite of leveraged and inverse commodity ETFs last week (see story here), saw early trading tilt heavily to the 200x leveraged Ultra DJ-AIG Crude Oil (NYSEArca: UCO).

"In the last few days, UCO has been averaging about 250,000 shares traded daily, and that's after only a week of availability. That is at the higher end of what we've seen in the past with launches," said Michael Sapir, ProShares' CEO.

The table below shows how flows flip-flopped from net withdrawals in October to significant net inflows in November.


U.S. Commodity ETPs 

Long ETP Nov. Asset Flows
($US millions) 

Long ETP October Asset Flows
$US millions

Energy ETPs  487  (720)
Precious Metals ETPs  290  (137)
Total ETPs  739  (1,605)
Source: Barclays Capital, Bloomberg


The Barclays Capital report commented that retail investors might now see the commodity markets as a "best value" asset class, most notably in the Energy sector, and one of the first places to look when reinvesting cash previously sitting on the sidelines.

Tale Of The Tape

It has been a tale of two years in one for the commodities sector. The first half of the year commodities soared toward a summer peak, before a spectacular crash that has extended all the way through today.

The PowerShares DB DJ AIG Commodity Long ETN (NYSEArca: DPU), which tracks one of the major commodity benchmarks, the Dow Jones-AIG Commodity Index, hit a 52-week intraday low on Friday.

Have prices bottomed? The ETF sponsors say it is still a story to be viewed subsector by subsector. In fact, in areas like Agriculture and some Metals, the story is still not positive. On balance, though, the November picture indicates to market observers that investors may be positioning themselves for a market bounce.

Commodities Skirt Credit Concerns

ETF Securities' Brooks, echoing the Barclays Capital report, said that investors seeking to capitalize on opportunities in a generally oversold market with less risk could lean toward commodities. "If there is a bounce across the board, investors may feel safer in commodities where there are not issues related to a company's debt position. Oil is oil and gold is gold. And not even the safest stocks seem safe in this market," said Brooks.

He added that with Oil, even if a market bounce doesn't occur, long-term investors are still buying at a price today that over a multiyear time horizon is very cheap. Also, since oil is a "cartel commodity," some people believe there is more control over its floor level.

"Zinc and oil are at prices below the cost of production for some producers, and that's a sign to some that if the sector has not bottomed out, we are getting closer and seeing people step back in on the long side," said Deutsche Bank's Rich.

He's less of a believer in the bounce hypothesis, though, than in the November commodity numbers showing that investors are positioning commodities as a long-term asset.

At the beginning of the year, the Deutsche products were at $3.5 billion in assets, and at the height of the commodity spike, hit $8 billion during the summer. Post-November, the family is just under $4 billion; take into account falling market prices, and it has more shares outstanding than it had before the boom-and-bust cycle played itself out.

Ultimately, this is not evidence of investors trying to time the market, or bet when a price is cheapest, but shows that investors think it is prudent to hold commodities as a diversifier in long-term asset allocation plans, Rich argues.

Still, could the long and leveraged commodities funds' resurgence in November be part of a general upswing in investor confidence?

ProShares presented one interesting piece of data that could support this hypothesis.

For almost all of its existence, ProShares' assets have been predominantly on the short side, generally at a level between 75% and 80%.

Sapir says that for the first time in the last few weeks, there have been several days when the asset balance between leveraged and short funds was approximately 50%-50%.



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