NOVEMBER 2, 2015 The Financial Advisor Magazine: Commodity Blues by Marla Brill
Commodity Blues
The bad news about commodity prices and the exchange-traded funds that follow them just keeps coming. Over the year ending September 30 the S&P GSCI, a broad commodity benchmark, fell 42%. The devastation was widespread, with each of the dozen components of the indexes posting negative returns ranging from negative 53% for oil to negative 19% for livestock.
The immediate future also looks grim, according to the latest report from the World Bank, which projects all main commodity price indexes will end the year lower and remain fairly flat in 2016. Some argue that most commodities have been in a bear market for more than two years.
Investors in the 140 ETFs that follow commodities have responded to all the bad news by heading for the exits. In 2015 alone, the largest broad-based commodity ETF, the PowerShares DB Commodity Index Tracking Fund (DBC) saw outflows of $982 million through September 30, while SPDR Gold Trust (GLD) lost $606 million.
The level of pessimism is so bad that even glimmers of hope are dismissed as a fluke. In a press release issued in late August, TrimTabs Investment Research noted that commodity ETFs experienced inflows from investors during the summer, despite their dismal performance. “Most investors are awful buyers and sellers,” the firm observed. “From a contrarian point of view, this could be a warning sign that things will get a lot worse.”
Despite all this, a number of advisors interviewed by Financial Advisor maintain varying degrees of loyalty to commodity ETFs and ETNs. Some say that while they aren’t investing in these funds now, they wouldn’t rule out doing so in the future. Others are hanging on to positions even as prices decline.
Chris McMahon
McMahon Financial Advisors
As a longtime resident of Pittsburgh, McMahon has seen how commodities can change the entire character of a region. “Years ago, Pittsburgh was a depressed steel town,” he says. “After the discovery of the Marcellus shale, people who used to sew their own clothes began getting $100,000 a month royalties on their land. Now, companies have cut back production because of low gas prices.”
Commodities have had an impact on client portfolios as well, albeit a small one. About eight years ago, McMahon’s firm began using commodity ETFs for diversification and inflation protection. The firm’s allocations range from 2% for conservative portfolios to 7% for the most aggressive ones, and the firm focuses on broad-basket offerings such as the United States Commodity Index Fund (USCI).
McMahon, who sees another 12 to 24 months of depressed commodity prices, intends to hang on to his current positioning. “Some investors might see this as an opportunity to buy commodity ETFs at lower prices. We’re asset allocators. We aren’t going to try and guess when commodities will start to explode.”
Several of these advisors say they prefer commodity exchange-traded notes over exchange-traded funds in taxable accounts. The latter vehicles use futures contracts and are organized as partnerships, so their tax treatment is fairly complicated and they generate a Schedule K-1 tax form. By contrast, exchange-traded notes, which are unsecured debt notes issued by banks that promise to provide the return of a specific index, are treated for tax purposes like regular stocks and bonds.