Comments on: Investing in Commodities; Base Metals http://www.fwallstreet.com/article/181-investing-in-commodities-base-metals/ Value Investing Blog Mon, 16 May 2011 10:55:06 +0000 hourly 1 http://wordpress.org/?v=3.3.1 By: Bram http://www.fwallstreet.com/article/181-investing-in-commodities-base-metals/#comment-2818 Bram Wed, 29 Apr 2009 19:17:37 +0000 http://www.fwallstreet.com/article/181-investing-in-commodities-base-metals#comment-2818 I'm still thinking on whether to agree with the analysis set forth in these 3 posts; however, I'd like to point out a few things: 1. Discussing futures shouldn't be the endpoint for your how your explanation how one can invest in commodities. Because, the ETF you invest in, is a so-called Excess Return ETF. I'm not completely sure of the strategy Deutsche employs for their ER ETFs but it will be some variation on the theme of buying a future and rolling it, such that the total notional value stays unchanged. E.g. suppose that the first WTI future is $50 and the second one $100 than they will sell 100 futures of the first contract and buy only 50 back. This is also one of the most important reasons why USO hasn't tracked oil performance well, because you only get excess returns relative to the current forward curve. In all fairness I have to point out that copper is in backwardation now, but certainly this hasn't been the case for a long time in a lot of metals. 2. The point of "copper = copper" doesn't really hold, though correlations might be high enough from a retail point of view to not really care in which you invest. 3. A thing I am missing in the analysis on how to value a commodity is whether it can be substituted by another commodity. For example gold and palladium can in some of their uses be substittued for each other. However, there prices did run completely out of line (and have over the last several weeks restored a bit). I’m still thinking on whether to agree with the analysis set forth in these 3 posts; however, I’d like to point out a few things:

1. Discussing futures shouldn’t be the endpoint for your how your explanation how one can invest in commodities. Because, the ETF you invest in, is a so-called Excess Return ETF. I’m not completely sure of the strategy Deutsche employs for their ER ETFs but it will be some variation on the theme of buying a future and rolling it, such that the total notional value stays unchanged. E.g. suppose that the first WTI future is $50 and the second one $100 than they will sell 100 futures of the first contract and buy only 50 back. This is also one of the most important reasons why USO hasn’t tracked oil performance well, because you only get excess returns relative to the current forward curve. In all fairness I have to point out that copper is in backwardation now, but certainly this hasn’t been the case for a long time in a lot of metals.

2. The point of “copper = copper” doesn’t really hold, though correlations might be high enough from a retail point of view to not really care in which you invest.

3. A thing I am missing in the analysis on how to value a commodity is whether it can be substituted by another commodity. For example gold and palladium can in some of their uses be substittued for each other. However, there prices did run completely out of line (and have over the last several weeks restored a bit).

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