Tag Archives: Commodities

Roubini Says Commodity Super Cycle “Is Over,” but Optimistic on U.S.

For a man nicknamed “Dr. Doom,” economist Nouriel Roubini sounded almost giddy during a recent speech in which he said the reduced possibility of a euro zone breakup has lowered the risk in the global economy.

While the global economy is anemic and still fragile, he said over the next three years growth in the U.S. will be faster than Europe, Japan and China because “the fundamentals of the U.S. are much better in all technologies of the future.”

Roubini, a professor of economics at New York University’s Stern School of Business, received the Dr. Doom moniker after he accurately predicted the 2007 bust in the housing market and the ensuing fiscal crisis in 2008.

But as he stood before a crowd of more than 100 at last month’s Inside Commodities conference, the chairman of Roubini Global Economics said while the U.S. economy remains weak, especially the housing sector, it will get stronger, albeit slowly. Nor does he expect a crash in the bond market.

“How can we create inflation without wage inflation?” he asked the crowd.

He expects the Federal Reserve Bank to begin tapering its policy of quantitative easing and begin raising interest rates by early 2014, which will lead to a gradual strengthening of the dollar. Quantitative easing, or QE3, is the name given to the Fed’s $85 billion-a-month bond-buying program now in its third round. Roubini said by the end of 2017 U.S. interest rates will be as high as 4%.

Yet for the audience of commodity investors, Roubini’s comments were decidedly bad news. He said high interest rates and the stronger dollar will have an inverse relationship to commodity prices.

“The party as we know it is over. The commodity super cycle is over,” said Roubini. “When the dollar gets stronger, everything else being equal, commodity prices begin to fall.” In addition, a slow down in China’s growth will reduce demand for commodities.

The economist said energy prices will gradually lower over time, with oil hitting $90 a barrel, and precious metals will fall too. He predicted the price of gold could fall to $1,000 an ounce by 2015. Rising interest rates and lowered global risk are big reasons for the drop in gold. He also thinks European countries may sell some of their gold stocks to reduce their public debt.

Even though the risk of the European Union splitting has declines, he pointed out that many of fundamental problems there are not resolved. Some countries remain in economic crisis, potential growth is low and the recovery will be “extremely anemic,” between 0% and 1%, which is lethal for the unemployed.

He said the loss of competitiveness in the Euro zone hasn’t been resolved and a fiscal drag remains. The recovery in the Euro zone “will be fragile and always be behind the curve.”

Another big unknown is whether China will have a soft or hard landing. Roubini said China’s growth is unsustainable and its leaders know it. He said the bubble from too much development, housing and investment will fall, along with consumption, and that will bring down growth. He said China’s growth rate at the end of this year will be 7%, sliding to 6% next year and less than 6% in 2015. While not a true hard landing, it will be worse than people expect.

The slowdown in China will cause a drop in demand for commodities which will hurt many emerging market economies. Countries with weakening fundamentals include Indonesia, India, Hungary and Ukraine.

While the prices for all commodities won’t fall for the same reasons, he says geopolitical factors, such as the lowering of tensions with Syria and Iran as reasons for the price of oil to fall. In addition, the balance of supply and demand, will be evened out and prices will decline with new discoveries of oil, as well as the rise of other forms of energy, such as shale. In addition, “the green economy will raise new energy and reduce demand for old energy.”

He recommended that investors be underweight in bonds and overweight in U.S. equities as the economic recovery become more robust and moves into cyclical stocks. He also believes Japan’s economy will succeed under Prime Minister Abe. He said investors should be overweight in advanced economies compared to emerging markets, and that the U.S. and Japan will do better than Europe and United Kingdom.

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List of ETFs That Issue K-1s Skips MLPs

I’m sure you’ve all heard the mantra for why ETFs are better than mutual funds: They’re cheaper, have greater transparency and flexibility and are much more tax efficient. That’s definitely true for ETFs that are structured at investment companies under the 1940 Act. These ETFs, which typically hold stocks or bonds, report their taxable gains and losses on IRS Form 1099.

However, some exchange-traded products are structured as partnerships, such as the ones that hold shares of master limited partnerships or futures contracts for commodities, currencies or volatility. Because of the creation/redemption system of acquiring securities, most ETFs don’t post capital gains. That means an investor only pays capital gains when he or she sells the shares in the fund.

However, limited partnerships pass through their taxes to the investor/partners every year. So investors need to pay taxes on any profits earned during the year. These investors receive a K-1 tax form, which outlines their profits or losses in the partnership over the past year. It’s a complicated form that can make figuring out and reporting taxes a big headache.

ETF Database has created what it calls the Complete List of ETFs that Issue K-1s. It’s a good list, but I don’t think it’s complete. It doesn’t list any of the ETFs that track master limited partnerships, which are usually companies that deal with natural resources.

Nonetheless, this is a good starting point on whether you should expect to receive a K-1 form from your ETP this year.

Suspected Front Running Cost USO $120 Million in February

The Wall Street Journal today reports that U.S. Oil (USO) has lost 20% of its value year-to-date, while the price of crude fell just 2.2%. The fund, which has grown from $7 million three years ago to $3.8 billion, is essentially losing money, and unable to track the crude oil market, because traders are front-running the roll. The roll is the movement from the first month contract that is soon to expire to the second month and soon-to-be front month contract.

Regulators are paying attention because it appears the fund is actually moving the market. Since U.S. Oil is so big and announces the day it will make the roll it appears speculators are making bets on these moves before they happen. The Journal says this is “adding to the costs of U.S. Oil’s roll and raising concerns among regulators that traders may be manipulating prices.”

“It’s like taking candy from a baby,” said Nauman Barakat, senior vice president at Macquarie Futures USA in New York, told the Journal. And this is hurting the fund’s investors.

The Journal reports that on the last roll, Feb. 6, U.S. Oil moved 80,000 contracts out of March into April. Thirty minutes before the New York Mercantile Exchange closed, the spread between the two month’s oil contracts jumped from $4 to $5.98, which cost the fund $120 million more than it would have a day earlier. At the same time, a trader could have pocketed $1,390 on each spread trade, which costs $810 to place.

The Journal says U.S. Oil complained to Nymex the following week. Last week, the Commodity Futures Trading Commission began investigating the trading.

Debating the WSJ’s Assessment of USO

In a continuation of yesterday’s post, It Takes Two (Months) to Contango, I want to focus a little more on the roll. The roll is what an investor, or speculator, in the futures market needs to do to keep their investment open and avoid taking delivery of the commodity in question. Remember, futures are an obligation to buy or sell a commodity at a certain price on the day the contract expires. If you don’t close the futures contract before it expires, you can expect a big truck to unload 1,000 barrels of oil on your lawn in a few days. Unless you’re running an oil refinery, this is not a good move.

Before expiration, investors betting on a commodity need to sell the contract for next month and buy the contract for the second month out. When the first month expires, the second month contract, becomes the new first month contract. Yesterday’s post dealt with the cost involved with the roll and how when the price of oil is rising, a trend called “contango,” you will earn less than the total movement in the spot price of the commodity. However, unless you want to take delivery, this is the closest way to play the spot price.

Last week I highlighted an article in the Wall Street Journal. It said the U.S. Oil Fund (USO), the exchange-traded product that is a pure play on the first month oil futures contract, is getting so large it’s affecting the oil market. The Journal writer Carolyn Cui says the $3.3 billion in assets held by USO accounts for 22% of the outstanding front-month contracts. According to Cui the fund is so large that on the day it moved from the March to the April contract, Feb. 6, it had a visible affect on the oil market.

I called John Hyland, the portfolio manager of the U.S. Oil Fund, to get his take on this. Hyland says you can’t blame a huge one-day move solely on USO without looking at the trend three days before the roll and three days after.

“The people who look just at the day we roll and say the spread was “X”, that doesn’t tell you anything,” says Hyland. “You have to look at the days leading up to and the days after. You might miss the trend going on if you just look at USO.”

For instance, if the three days before the roll, the spread on the contract was $1 and the day of the roll the spread jumped to $2, then you can say there was an affect.

According to Hyland, the three days before Feb. 6, when USO rolled over its contract, the spread between the March and April contracts were $3.99, $3.87 and $3.88. The day USO rolled it jumped to $4.55. However, the next day the spread grew to $4.76 and over the next few days jumped to $4.81, $5.24 and $6.06, eventually widening to $8.19.

“The spread is tending to move wider as you get into the middle of the month, as March gets closer to expiration. Is that USO’s doing? How are we doing it after our roll?” asks Hyland. “It looks to me that as we get closer to expiration, it’s more of an inventory issue. The people who say it must be USO are not really looking at everything.”

Inventories are rising. If demand for oil drops off a million barrels a day and OPEC produces the same amount of oil, then inventory goes up million barrels a day. A lot of oil in the tanks is not bullish for the March contract. With supply rising and inventories hitting 52-week highs, one would expect the oil price to weaken. If OPEC cuts production, the shortfall will be made up from the current inventory. As inventories get smaller, the front month contract will stop trading at a big discount to the contracts further out.

People are assuming inventories will not build up indefinitely. OPEC will have to reduce production, if for no other reason than they will run out of storage tanks. Since the cheapest place to store oil is in the ground before you pump it out, they will cut production. At that time, inventories will start to shrink.

Market Folly, the blog posting I ragged on yesterday, actually has an interesting slide presentation from the International Energy Agency from November called The Era of Cheap Oil is Over. It’s a good read for anyone investing in oil.

It Takes Two (Months) to Contango

Caveat emptor.

It’s Latin for buyer beware. There’s no doubt that a lot of people in this world want to make money off of selling you junk. In fact, that’s a pretty good assessment of the entire collateral debt obligation market. If buyers had paid a little bit more attention to what they were buying, we might not be in the financial mess destroying the country.

ETF companies aren’t selling junk, but investors still need to be aware of what they’re buying. Many ETFs are extremely sophisticated instruments. Investors may think they are buying one thing, when in fact they are buying another. The problem isn’t with the ETFs. These transparent instruments lay it all out in the prospectus and usually in the easy-to-read fact sheet on their Web sites. The problem is investors need to do their homework.

For example, Tradefast, an independent equity trader at a private investment fund, writes on the MarketFolly blog about how contango affects the crude oil ETFs. He says “three factors play a role in determining the performance of the United States Oil Fund (USO): 1) changes in the spot price of crude oil, 2) interest income on un-invested cash, and 3) the ‘roll yield’.”

Unlike the two gold ETFs, the StreetTracks Gold Trust (GLD) and iShares COMEX Gold Trust (IAU), which actually hold gold bullion, USO doesn’t hold the underlying commodity, barrels of oil. It owns oil futures contracts.

While the spot price of crude oil, the price it costs to buy a barrel of oil today for immediate delivery, may affect how investors buy or sell this exchange-traded vehicle, USO doesn’t track the spot price. It holds holds the front month futures contract, which is where oil traders expect the price of oil to sell for a month from now.

So, while the spot price will influence where investors expect the price of oil to be a month from now, they don’t necessarily move together. For example on Friday, anticipation that passage the economic stimulus package going through Congress would increase demand for oil, the price of the March crude futures contract for West Texas Intermediate crude oil jumped $3.53, or 10.4%, to $37.51 a barrel on the New York Mercantile Exchange. Meanwhile, the spot price closed Friday with a bid/ask spread of $37.60 to $37.65, according to the Australian Associated Press.

USO investors hoping to capture the spot market’s Friday gain were surprised to see the ETP actually fall 1.2%. That’s because the previous Friday the fund had rolled out of the March contract and bought the April contract to avoid taking delivery of the actual oil this Friday. So, while the March contract jumped 10%, the NYMEX April crude contract fell 0.47% to $41.97.

It’s the forward roll from the first month contract (March) to the second, and future first, month contract (April) that upsets MarketFolly. When the price of oil is rising, it’s in a trend called “contango”. This means that demand for oil in the future is greater than today, or that future supplies will be tighter. So, when you sell the first month contract, you have to pay up to buy the next month’s contract. It’s not a straight line up like in a stock. If you sell the March contract at $37.50 and buy the April at $41.97, you have to pay an additional $4.47 per contract. This additional cost eats into returns. Well, with a little bit of research, such as reading this story I wrote for SmartMoney.com when USO launched three years ago, he wouldn’t have been so surprised.

MarketFolly then realizes that “USO is not a direct play on the spot price of crude oil – it is, instead, a play on the spot price, forward prices, and the relationship between spot and forward (the slop of the futures curve).”

Because of this he says that USO is not a good way for investors to play the price of oil. For some reason, the FT Alphaville blog from the Financial Times agrees with this ridiculous assertion. Since investors can’t buy the spot price of oil without taking delivery, you have to buy futures to make any kind of play on the price of oil. So, all investors pay the roll, not just USO. If investors were buying futures and not the ETP they would have to make the same kind of trades USO makes, pay the same cost of the forward roll, plus the transaction costs.

What Tradefast fails to realize is “being in contango doesn’t means you lose money,” says John Hyland, the portfolio manager of USO. “Being in contango means you underperform the spot price. If the price of oil rises $100 again, even in a contango market you still make money. You just make less that the return in spot, say $90. They just focused on one half of the equation.”

Hyland says in the reverse scenario, backwardation, when the price of oil in the second future month is lower than the near month contract, the investor would outperform the spot price, but that doesn’t mean you make money. “Spot can fall 50% and you fall 40%. So you outperformed the spot price, but you still lost money.”

Commodity, Currency Short Funds Launched

ProShares Funds, the creator of inverse and leveraged ETFs, launched eight new funds on the NYSE Arca Tuesday.

ProShares Ultra DJ-AIG Commodity (UCD)
ProShares UltraShort DJ-AIG Commodity (CMD)
ProShares Ultra DJ-AIG Crude Oil (UCO)
ProShares UltraShort DJ-AIG Crude Oil (SCO)
ProShares Ultra Euro (ULE)
ProShares UltraShort Euro (EUO)
ProShares Ultra Yen (YCL)
ProShares UltraShort Yen (YCS)

ProShares offers 64 ETFs that provide investors with short and leveraged exposure to a wide variety of stock and bond indexes.

PowerShares Takes on Van Eck During Market Mayhem

Amidst the mayhem on Wall Street, Invesco PowerShares Capital Management launched six new ETFs on the Nasdaq Stock Market. If you wonder why, it’s because it can take so long to get an ETF through the regulatory process, that when the SEC approves your application, you pretty much go ahead with the launch, even if the market is crashing all around you .

It appears that PowerShares is taking on Van Eck in the area of commodity stock, killing Van Eck’s monopoly on steel, gold and coal stock funds.

* PowerShares Global Agriculture Portfolio (PAGG) seeks investment results that correspond to the price and yield performance of the NASDAQ OMX Global Agriculture Index.

* PowerShares Global Coal Portfolio (PKOL) will track the price and yield performance of the NASDAQ OMX Global Coal Index.

* PowerShares Global Steel Portfolio (PSTL) follows the NASDAQ OMX Global Steel Index.

* PowerShares Global Gold and Precious Metals Portfolio (PSAU) will track the NASDAQ OMX Global Gold and Precious Metals Index.

* PowerShares Global Progressive Transportation Portfolio (PTRP) seeks results that correspond to the Wilder NASDAQ OMX Global Energy Efficient Transport Index(sm).

* PowerShares Global Biotech Portfolio (PBTQ) follows the NASDAQ OMX Global Biotechnology Index.

With these six new ETFs, PowerShares has listed 12 ETFs on the Nasdaq this year. Currently, 27 PowerShares ETFs list on the Nasdaq.