JPMorgan Plans Physically-Backed Copper ETF

by on October 26, 2010 | ETFs Mentioned:

Innovation throughout the ETF industry has been one of the primary themes of recent years, but perhaps no corner of the market has seen more progress on the product development front than the commodity space. U.S. investors now have the ability to invest in dozens of natural resources, primarily through exchange-traded funds than consist of futures contracts. In addition to an increase in the number of products available, issuers have continued to refine the manner in which exposure is offered by tweaking the rules for rolling holdings and revising index components [see Closer Look At The Third Generation Commodity ETF]. 

As evidenced by strong cash inflows into commodity ETPs, investors have embraced the ETF wrapper as an efficient means of establishing exposure to an asset class that has the potential to add valuable return enhancement and diversification benefits to traditional stock-and-bond portfolios. But some investors have also expressed frustration over the returns generated by futures-based investment strategies, which will generally exhibit strong correlations to spot prices but may lag behind a hypothetical return on the physical commodity due to costs incurred when “rolling” the underlying futures contracts [see the Many Uses Of Commodity ETFs].

Against this backdrop, JPMorgan recently filed with the SEC plans for a physically-backed copper ETF that would offer investors a way to gain exposure to the widely-used metal without the complexities of a futures-based strategy. The trust formed by JPMorgan would hold “only Copper Grade A in physical form,” and shares would be priced to correspond to the value of 1/100th of a metric tonne of copper.

Currently, there are eight physically-backed commodity funds, including three focused on gold, two on silver, and one each on palladium and platinum. Last week, ETF Securities launched GLTR, which offers exposure to a basket consisting of those four precious metals.

While a physically-backed copper ETF would eliminate the contango-related nuances that can plague existing industrial metal funds, other issues may arise. Because precious metals maintain high value-to-weight ratios, these funds are able to charge relatively low expense ratios (IAU charges just 25 basis points). A physically-backed copper ETF, on the other hand, could potentially spend a material portion of assets storing the underlying holdings. According to the prospectus, the proposed fund would utilize warehouses maintained by Henry Bath Group, a firm that operated a platform of exchange-approved storage warehouses in the United Kingdom, Italy, Singapore, Netherlands, and the U.S.

Regulatory Hurdles

Physically-backed industrial metals ETFs will likely draw considerable scrutiny from U.S. regulators. While U.S.-listed gold ETFs hold more than $60 billion in bullion (some of which is stored outside the U.S.), the impact on prices hasn’t been widely discussed because there are few industrial uses for the metal. A physically-backed copper ETF, on the other hand, could potentially accumulate inventory levels that would influence global prices and disrupt the operations of countless businesses [read Three ETFs To Watch As The Housing Market Crumbles].

The fund proposed by JPMorgan would be a first for the U.S. industry, although physically-backed metals ETFs are close to becoming a reality in Europe. ETF Securities, a giant in the European ETF space that now offers five physically-backed funds to U.S. investors, has recently been laying the groundwork for a suite of funds focusing on industrial metals that would invest directly in physical stocks of copper, aluminum, zinc, nickel, lead, and tin, as well as a basket of all six major base metals [see Are Physically-Backed Metals ETFs A Bad Idea?].

Growing Lineup

To date, JPMorgan’s forays into the ETF industry have been limited but successful. The company launched the first exchange-traded note linked to an MLP index in early 2009; since then the JPMorgan Alerian MLP Index ETN (AMJ) has accumulated nearly $2 billion in assets. More recently, JPMorgan rolled two leveraged Treasury ETNs, the Double Short U.S. Long Bond Treasury Futures ETN (DSTJ) and the Double Short U.S. 10 Year Treasury Futures ETN (DSXJ), that offer investors options for leveraging rising rates views at the medium and long parts of the U.S. Treasury curve.

Existing ETF Options

There are currently a number of ways for investors to gain exposure to copper through exchange-traded products. The best pure play is the iPath Dow Jones UBS Copper ETN (JJC), which is linked to an index comprised of a futures contract on copper. Because the underlying index utilizes a futures-based approach, JJC is susceptible to erosion of returns in contangoed markets and enhancement of returns when the futures curve is backwardated [read Behind The Copper ETN's Impressive Rally].

There are also multiple funds that offer exposure to copper prices through equities of companies engaged in mining for the metal. These include the Global X Copper Miners ETF (COPX) and First Trust ISE Global Copper Index Fund (CU). Between these two, COPX is more of a pure play on copper mining stocks, as the First Trust fund includes allocations to Rio Tinto and other firms that are engaged in mining for a variety of precious and industrial metals.

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Disclosure: No positions at time of writing.