Many Uses Of Commodity ETFs

by on August 4, 2010

Although many of the largest and most popular exchange-traded funds offer exposure to equities, it is another corner of the ETF market that has been primarily responsible for the impressive growth spurt that the industry has enjoyed over the last several years. In 2009, commodity ETFs saw cash inflows of more than $30 billion. Through the first six months of 2010 that pace had slowed considerably, but the cash flows are still impressive; more than $7.5 billion flowed into commodity ETFs in the first two quarters of the year.

The tremendous interest in these products is relatively easy to understand. Prior to the rise of the ETF industry, commodities were beyond the reach of many investors. Trading futures contracts requires certain approvals, while physically storing commodities obviously involves some logistical obstacles. Moreover, maintaining commodity exposure through futures contracts requires ongoing monitoring and management that becomes time consuming (and expensive) for most investors. ETFs have democratized the commodity asset class, allowing all levels of investors to establish and maintain exposure to natural resource prices with relative ease and cost efficiency [see also The Next Generation Of Commodity ETFs?].

Much like equities, different investors use commodities in different ways. Some use commodities to speculate on the direction of natural resource prices, betting on a big swing in prices in a relatively short period of time. Others maintain a longer time horizon, embracing commodities as a way to hedge against an uptick in inflation. And then there are those that utilize commodities as a diversifying agent, or assets that maintain low correlations with stocks and bonds [also read The Complete Guide To Commodity ETFs].

But the potential uses of commodity ETFs don’t stop there. Some natural resources maintain a strong link with certain corners of the domestic or global economy, thereby offering a way for investors to play larger macroeconomic trends. Below, we profile five ways to use commodity ETFs to bet on the global economy [also see What Every Investor Should Know About Commodity ETF Investing]:

1. Betting On Housing Sector With JJC

China is the world’s largest user of copper, and prices of this metal often react to major economic developments out of the world’s largest emerging market. Within the U.S., the homebuilding industry is a big copper user, employing the metal in wiring found in new homes. As such, an investment in the iPath Dow Jones-UBS Copper ETN (JJC) is one way to bet on a recovery in this corner of the U.S. economy. If homebuilding activity picks up copper prices are likely to rise, and vice versa [also see Three Reasons Why The Copper ETF Is Soaring].

2. Betting On Auto Industry With PALL

Palladium, one of the rarest metals on earth, is accessible through the ETF Securities Physical Palladium Shares (PALL). Perhaps without knowing it, most investors make use of this metal every day; it is one of the primary components of catalytic converters used in automobiles. In fact, the automotive industry accounts for approximately half of global palladium demand, forming a relatively strong link between the price of this metal and the health of the automotive industry. There’s no car ETF available (Direxion has filed for one), but investors can establish indirect exposure to the auto industry through an investment in the palladium ETF [also read PALL Plunges, Screaming Buy?].

3. Betting On Ethanol Boom With CORN

One of the most recent commodity products to hit the commodity market is the Teucrium Corn Fund (CORN), a product that offers exposure to exchange-traded corn futures [see Case For A Corn ETF]. One of the primary U.S. exports, corn has historically been used exclusively as an agricultural product. But in recent years, a new source of demand for corn has popped up; this commodity is one of the primary inputs in ethanol. With an increased focus on alternative energy, some investors are expecting demand for ethanol to surge in coming years. If that happens, the price of corn could skyrocket, making CORN an interesting way to play an energy-related trend.

4. Betting On A U.S. Recovery With UNG

In recent years, investors have lamented that international diversification let them down just when they needed it most; European equity market tumbled as the U.S. financial sector melted down in 2008, and the opposite scenario played out earlier this year. With global financial markets more interconnected than ever before, finding a “pure play” on the U.S. economy is a challenging task.

The United States Natural Gas Fund (UNG) offers exposure to natural gas, a commodity that is unlike almost every other resource. Because the physical properties of natural gas make long-distance transportation difficult and expensive, it remains largely a local economy. Natural gas delivered in Louisiana never ends up in Europe, providing a sort of natural “insulation” for this fund; since there is virtually no overseas demand for the natural gas underlying UNG’s futures, the price of these contracts depends primarily on domestic demand [also see Natural Gas: Investing In The Fuel Of The Future].

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If economic activity in the U.S. picks up, UNG will likely get a boost. The same can’t be said for most equity funds, which are vulnerable to economic weakness in other regions of the world.

5. Betting Against The Recovery With GLD

The SPDE Gold Trust (GLD) is by far the largest exchange-traded commodity product, currently maintaining more than $50 billion in assets. Gold is one of the most popular “safe haven” investments, serving as an attractive place to park assets during tumultuous economic times [see Five Safe Haven ETFs]. For investors who think the global economy is headed for a double dip, GLD is an interesting option that generally maintains a low or negative correlation with equity markets.

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Disclosure: No positions at time of writing.