The Next Generation Of Commodity ETFs?

by on June 2, 2010 | ETFs Mentioned:

ETF Securities, the London-based firm that holds a big slice of market share on the European ETF scene, has established itself as a formidable player in the U.S. market in its first year in the game. The company’s gold (SGOL) and silver (SIVR) ETFs have been successful in competing with much larger, well-established products, and overwhelming demand for the first-to-market physically-backed platinum and palladium ETFs recently led to the creation of new shares.

Having built out its line of precious metals ETFs, many wondered what was next for ETF Securities. Thanks to a filing with the SEC made last week, we may now have an answer. ETF Securities made a filing detailing 18 new commodity products. The list of proposed funds includes products offering exposure to oil, natural gas, copper, wheat, and gold, as well as several inverse and leveraged versions.

1x Long ETFs 2x Leveraged Inverse
Ex-U.S. Oil Ex-U.S. Oil Ex-U.S. Oil
Natural Gas Natural Gas Natural Gas
Copper Copper Copper
Wheat Wheat Wheat
Industrial Metals
Composite Energy
All Commodities
Gold Gold

All of the proposed products would offer exposure to commodities already covered by a number of existing ETPs, many of which have the benefit of a significant asset base and hefty trading volumes. But the ETF Securities versions could have one unique difference that some think could make them very appealing to investors. Instead of investing in futures contracts like many of the most popular exchange-traded commodity products, “each fund will hold fully collateralized, prepaid forward Commodity Contracts.” That may not sound like a major distinction, but it could have a material impact on the tax bill investors receive at the end of the year for their commodity positions (see How Contango Impacts Commodity ETFs).

Futures-based commodity ETFs are taxed at the same rate as futures contracts, meaning that regardless of how long a position is held, any gains will be taxed as 60% long-term and 40% short-term. Moreover, futures-based ETFs are marked to market at the end of each year, meaning that investors lose control over when gains will be recognized.

The proposed ETF Securities funds may be more efficient within a taxable account. “The new funds will own swap contracts linked to futures rather than purchasing the futures themselves,” writes Matt Hougan. “The advantage is that the swaps in this case will be structured as ‘prepaid forward contracts.’ That’s a magic word in commodities.” Prepaid forward contracts are not marked to market, and are generally taxed like equities. So for investors holding positions for more than a year, there may be some opportunities to improve tax efficiency. It’s worth noting, however, that ten of the 18 funds detailed are either leveraged or inverse products; ETFS notes in the filing that these products “are intended to be used as short-term trading vehicles.”


It’s too early to tell whether the ETFs outlined in the recent filing will be gamechangers in the commodity space, but they could certainly expand the universe of options available to investors and send issuers already in the space back to the drawing board. But the introduction of more tax-efficient commodity products could also spur the IRS to take a closer look at the existing code and take a more definitive stance on certain “gray areas,” a scenario that may not be beneficial to investors.

Stay tuned–it will be interesting to see how the latest evolution in the commodity ETF space plays out.

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Disclosure: No positions at time of writing.