A Spate Of Downsizing
The other problem with relying on swaps contracts to build the funds is that the CFTC is unlikely to overlook them when it comes to making a final decision on the rules regarding commodity ETPs, says Bradley Kay, an ETF analyst with Morningstar in
“My feeling is that a lot of tricks UNG used will be addressed by the CFTC,” said Kay. “It would be a little silly for the CFTC to come down very hard on position limits and ignore the loopholes, since that means it no longer matters how large the fund gets.”
Barring further use of swaps, the managers’ only options are likely to be how to limit the growth of, or even downsize the funds. USCF’s Hyland admitted this week that “at the far extreme,” making UNG smaller would be the only remaining option.
If position limits are set prior to their current levels, funds will be forced to either sell assets to cover their newly reduced limitations, or possibly, to issue a tender offer for their own shares. The consequences of that action are still unpredictable, but they are possibly dire for many of today’s rallying commodities markets.
Adding Some Perspective
In the past week, the problem of issuing new shares for commodity exchange-traded products has been rapidly building to a head, but it first started in April. Back then, investors began snapping up shares of the UNG, an ETF linked to the price of natural gas, as they bet on a big rebound in the price of the commodity after the first signs of green shoots began to appear in the global economy. (See related story here.)
Unfortunately for investors in UNG, regulators were not so forthcoming in handing out approval of further share issuances. While they mulled the decision, UNG began to show signs of trading at a slight premium to the price of natural gas, as investors cast aside fears of overpaying for the underlying commodity in preference for having exposure to it.
More commotion began last week when the CFTC announced it was revoking exemptions to the creation of position limits in agricultural commodities by the PowerShares DB Commodity Index Tracking Fund (NYSEArca: DBC) and PowerShares DB Agriculture Funds (NYSEArca: DBA). That decision prompted a temporary halt in the issuance of new shares on the PowerShares DB Crude Oil Double ETN (NYSEArca: DXO) a day later. (See related story here.)
Monday, Barclays Global Investors followed suit, and said it was issuing a halt to the creation of new shares of its iShares S&P GSCI Commodity Index Trust (NYSEArca: GSG) product once the outstanding number of shares reached 55.9 million. The total outstanding shares for GSG is approximately 52 million right now. The iPath Dow Jones-AIG Natural Gas (NYSEArca: GAZ) also intends to stop issuing new shares once it hits its position limit. (See related story here.)
“[Fund providers] don't want to be caught in a spot where they have to unwind positions in order to come in under any limits. It appears that they’re being prudent?causing a little hassle now to save a lot of hassle later,” said Tom Lydon, president of Global Trends Investments. “We could continue to see more and more funds do this up until the CFTC makes an announcement.”