Lucky Seven?

January 08, 2007

PowerShares launches seven new commodity sector ETFs on the Amex; bold claims for important new products.

Investors who want to fine-tune their commodities exposure got a new set of options on January 5, when PowerShares launched seven sector-based commodity exchange-traded funds (ETFs) onto the American Stock Exchange (AMEX).  The new funds were launched in partnership with Deutsche Bank, and follow in the footsteps of the broad-based PowerShares DB Commodity Index Fund (AMEX: DBC), the first (and still the largest) commodity index ETF in the U.S.

The new funds are the:

PowerShares DB Energy Fund (DBE)
PowerShares DB Oil Fund (DBO)
PowerShares DB Precious Metals Fund (DBP)
PowerShares DB Gold Fund (DGL)
PowerShares DB Silver Fund (DBS)
PowerShares DB Base Metals Fund (DBB)
PowerShares DB Agriculture Fund (DBA)

You can find the prospectus here.

Like DBC, the funds track the performance of fully collateralized futures investment in the given commodity or commodities.  That means that each fund gets its returns from three sources:

1)    Changes in the spot price.

2)    Collateral interest, i.e., money not invested in futures is invested in Treasuries.

3)    Roll yield, i.e., the price difference (positive or negative) achieved each time a contract is rolled from one expiring futures contract to another.

The oil, gold and silver funds will charge 50 basis points; the other funds will charge 75 basis points. Those expenses will be covered by the collateral interest income, which will approach 5 percent per year based on current interest rates.

Like DBC, the new ETFs track something Deutsche Bank calls its "Optimum Yield" indexes. All futures-based indexes must roll their contracts from one month to the next as each contract expires; typically, they simply sell the expiring contract and purchase the next, i.e., sell January and purchase February.

The "Optimum Yield" indexes, however, instead have the flexibility to "select" the best-priced contract looking out as far as 13 months. That is supposed to improve the "roll yield."  As explained below, PowerShares and DB are making some bold claims about the robustness of this process; it remains to be seen whether those claims will hold up over the long hall.

Potential Uses And Concerns

Investors can work with the funds in different ways.  The most obvious use is to go long or short one particular sector - say, to make a bet on agriculture, energy or silver. In most cases - and particularly in the case of the agriculture and base metals ETFs - the funds offer the first opportunity for ETF investors to make a futures-based investment in each sector. 

Investors can also use the funds to create a "pairs trade" with a broad-based commodity index ETF.  For instance, you could buy the broad-based DBC but hedge against the current negative roll yield in the energy sector by shorting the PowerShares DB Energy Fund.

The funds, however, have unique quirks, which should be considered by investors looking for a commodities investment.

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