Floods & Tariffs Lift Grain ETFs

As the Midwest has struggled with climate-related disasters, grain prices have spiraled higher, in turn boosting returns for agricultural commodity exchange-traded products.

Commodity funds across the agricultural complex are exhibiting strong performance, with wheat and grain ETPs posting the highest one-month gains.

Top performers include the Elements MLCX Grains Index-Total Return ETN (GRU), which has risen 17%; the Teucrium Wheat Fund (WEAT), which has risen 16%; and the iPath Series B Bloomberg Grains Subindex Total Return ETN (JJG), which has risen 14%.

Other top performers include the Teucrium Corn Fund (CORN), which has risen 13%; and the iPath Series B Bloomberg Coffee Subindex Total Return ETN (JO), which has risen 10%.

All told, five of the top 10 best-performing ETFs of the past 30 days have been agricultural ETPs:

Source: ETF.com; data as of June 4, 2019

Heavy Rains Lift Prices

The reason behind these ETFs' outperformance is simple: Grain prices are rising on weather-related supply concerns, particularly in the U.S.

Weeks of torrential rains across the Midwest and South have swollen rivers, broken levees and flooded fields, leaving farmers from Indiana to Arkansas well behind on their yearly plantings.

A USDA report published earlier this week showed that only 67% of this year's corn crop had so far been planted, leaving just under 31 million acres left to plant. That's well below five-year averages, where 96% of the corn crop had historically been planted by this time of year.

Soybean plantings were below average too, with 39% of the crop planted compared with a five-year average of 79% for this time of year.

Record-breaking heat and drought conditions elsewhere in the world, even elsewhere in the U.S., have further increased supply concerns.

Trade War's Impact On Crops

For soybeans, specifically, the U.S.-China trade war has further complicated matters. Historically, China has been a significant importer of U.S. soybeans, but due to the tariffs, the country has held off on its usual purchases.

With demand down, farmers simply aren't planning to plant as many soybeans as they have in the past. Nor can they be assured that the crop they have planted will eventually find buyers.

Additional tariffs levied on Mexico—one of the U.S.' largest agricultural import/export partners—are likely to further impact supply and demand.

The situation has reached such crisis levels that the U.S. is bailing out its own farmers to the tune of $16 billion in disaster relief, including $14.5 billion in cash payments funded by income generated from tariffs.

Agricultural ETPs: Not Like Other ETFs

When it comes to agriculture, concerns about future supply and demand are often priced into futures contracts (as opposed to spot prices); hence why so many grain ETFs, which track futures or futures-based indexes, are popping right now.

However, investors should be aware that most commodity ETPs—including agricultural ones—aren't structured as familiar open-ended, '40 Act funds.

For example, WEAT and CORN are commodity pools, an older ETF structure designed to hold futures contracts on behalf of investors.

The main benefit of commodity pools is their more favorable tax treatment for short-term traders. Whereas open-ended funds are taxed according to how long they're held, commodity pools are taxed according to a time-agnostic "60/40 rule." As such, 60% of their gains will always be taxed at the lower long-term tax rate of 20%, no matter how long they're in your possession, while the remaining 40% is taxed at the higher short-term rate of 34.6%.

For traders holding these funds for less than 12 months, a commodity pool ETF will have a more favorable tax treatment than a traditional open-ended fund.

Pros & Cons Of Commodity Pool ETPs

WEAT and CORN both track an index of wheat and corn futures, respectively, that includes the second and third contracts from expiry, as well as the next December contract following the third contract. These three batches of futures are weighted at 35%, 30% and 35%, respectively.

Spreading out exposure along the futures curve has the potential to boost returns during times of steep contango (a condition in which futures contracts that are further away from expiry have higher prices than those nearer to expiration). But diversified futures exposure can also nudge a fund's returns away from those of spot and front-month futures.

WEAT and CORN—the only ETFs to offer pure-play exposure to the futures contracts of their respective grains—are also notable for their sky-high expense ratios: WEAT has an annual cost of 3.63%, while CORN has an annual cost of 3.65%. That, combined with not-insignificant spreads, can make the cost of trading and holding these ETFs substantial.

ETNs Also An Alternative

Another downside of commodity pools is that they issue a K-1 form at tax time, which can add to filing delays and headaches for investors unfamiliar with the form (read: "K-1 Taxes Hurdle For Commodity ETFs").

This is something that GRU, JO and JJG avoid, as they are all exchange-traded notes (ETNs).

ETNs are debt notes issued by a bank that promise to deliver the returns of a given index, less fees. Because ETNs don't have to buy or sell futures contracts, their tracking error to their benchmarks is often much lower than funds that must trade actual portfolios.

They also tend to have lower management fees.

Yet ETNs carry with them the risk of issuer default: Should the bank that issues them go belly up, the ETN shareholders presumably would be out of luck. It's unlikely, but it has happened in the past, such as when Lehman Brothers went bust (read: "The Lehman Bros. ETN Fallout").

Series B Adds Improvements

GRU tracks an index of front-month futures contracts for the three major grains—soybeans, corn and wheat—as well as for soybean oil. JJG, meanwhile, tracks a production- and liquidity-weighted index of grains futures contracts, each ranging from one to five months from expiration.

JO, which tracks coffee futures, tracks a single futures contract either two or three months out and holds until maturity.

Notably, JO and JJG are part of Barclays' "Series B" line of ETNs, a suite of notes mostly identical to older products, but updated with several investor-friendly attributes, including a call feature and lower expense ratios (read: "iPath Commodity ETNs Return To Old Tickers").

Agriculture ETPs Lag In Assets

Neither the commodity pool funds nor the ETNs have gained much in the way of investor assets. Year to date, the largest agricultural commodity ETF is the Invesco DB Agriculture Fund (DBA), which has $432 million in assets under management. All other agriculture ETPs have less than $100 million invested.

Source: ETF.com; data as of June 5, 2019

Contact Lara Crigger at [email protected]