What’s Next For Commodity ETFs?

August 26, 2009

As regulators increase their focus on the sector, advisers and money managers are putting several well-known funds on their watch lists.


Editor’s note: The following is the first installment in a two-part series looking at the fallout of the ongoing regulatory probe into commodity-focused exchange-traded products. (See part two here.)


Just as commodity prices are finally showing signs of life, many investors in exchange-traded products focusing on everything from oil to precious metals are fretting over the impacts of regulatory clampdowns.

Nobody knows how long the ongoing debate will rage in
Washington, D.C. But the longer federal authorities take to decide whether to place limits on commodity investments, the more likely it becomes that a greater number of ETPs will be forced to act like close-end funds.

Exactly which products those will turn out to be remains unclear. Still, several prime candidates being mentioned within the industry?both in institutional as well as individual advisory circles?include a number of well-known ETP names. (The all-encompassing ETP category covers traditional exchange-traded funds and exchange-traded notes as well as hybrid commodity pools and other sophisticated open-end funds that trade on exchanges.)

Prime candidates some advisers and institutional money managers are putting on their watch lists right now include: The United States Heating Oil Fund (NYSEArca: UHN); the United States Oil Fund (NYSEArca: USO) and the PowerShares DB Energy Fund (NYSEArca: DBE).

Further down the line, there is even speculation that the SPDR Gold Shares (NYSEArca: GLD) and the iShares Silver Trust (NYSEArca: SLV) may come under scrutiny by the U.S. Commodity Futures Trading Commission and the Securities and Exchange Commission.

The amount of precious metal these funds hold rivals that of central banks. GLD, for example, holds $32 billion of gold?more than many emerging market central banks, including Malaysia, Bulgaria, Mexico, Peru and even

Swaps Only A Short-Term Solution

One way in which these funds might try to circumvent CFTC regulations is to enter into swaps contracts. Such a move could allow ETP firms to dodge their position limits on holding the raw commodities. For instance, last week the U.S. Natural Gas Fund (NYSEArca: UNG) entered into a $500 million swap. (See related story here.)

Using swaps contracts enables an ETF to enter into an agreement with a market counterparty (for a fee), whereby it agrees to pay or to be paid the difference in the value of the commodity at the end of a specified period. In this way, UNG can still replicate the performance of the price of natural gas without actually holding any gas itself.

But swaps contracts are only available in limited sizes, and right now they don’t seem like a long-term solution to expanding the size of an ETF aiming to track the price of a single, widely traded commodity, such as gas.

John Hyland, chief investment officer for United States Commodity Funds, which manages the UNG, said in a statement this week that “these natural gas-based swaps are not enough by themselves to allow us to either meet what we think such potential CFTC levels might be, or to permit us to prudently allow new creations.”


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