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HFM Columbus warns about highly volatile ETFs and negative roll yields


Commodities could be a good buy now following big price falls, but investors need to exercise caution as to which investment vehicle they should use, according to wealth manager HFM Col

Commodities could be a good buy now following big price falls, but investors need to exercise caution as to which investment vehicle they should use, according to wealth manager HFM Columbus.

Investment director Rob Pemberton suggests investors access potentially excellent longer term gains via a unit trust fund investing in commodity-related equities such as oil exploration or gold mining companies, or in the case of precious metals, a proven exchange traded fund, which tracks the commodity’s performance.

‘Cast your mind back to summer 2008 and the oil price peak of over USD140 a barrel, when gold touched the magic USD1,000 an ounce, base metals surged and even wheat and soybeans joined the party,’ says Pemberton.

‘But since then prices have collapsed – and let’s face it, who wants commodities in a deflationary environment? But forward looking investors will be assessing the possibility that the huge amounts of money being pumped into the global economy may in time prove to be strongly re-flationary.

‘While the outlook for industrial commodities is not bright in the short term, accumulation now after big price falls is a sensible hedge against a possible surge in commodity demand or an inflation scare in the next couple of years,’ he adds.

If going into a commodity exchange traded vehicle, Pemberton reminds investors that these do not necessarily track the spot price of the commodity but frequently the price in the futures market.

‘Because of the mechanism of trading in this market, the investor can suffer a ‘contango’ or ‘negative roll yield’ effect (in practice a large additional cost) if the curve of future prices is sloping upwards, which is currently the case,’ he explains.

‘In the first quarter of 2009 for example, energy spot prices rose strongly but investing in an ETF of underlying one month future contracts could actually have lost you money due to this contango effect.

‘A general fund investing in commodity related equities such as oil exploration or gold mining companies is the often the best bet for all but the most risk embracing investor.’

HFM Columbus’ recommendations include funds JP Morgan Natural Resources for general commodity exposure and Investec Global Energy or BlackRock Gold and General for a more specific approach, as they avoid the contango issue, have no counterparty financial strength issues (unlike some ETFs) and have daily liquidity (unlike ‘managed future’ funds or hedge funds).

‘Their correlation with the underlying commodity can leave something to be desired in the short-term,’ says Pemberton. ‘But over the long term they should prove to be a decent proxy.’

On the issue of gold and other precious metals, Pemberton reminds investors that they behave very differently to other commodities.

‘Gold is an excellent portfolio diversifier and is regarded as a traditional safe haven and store of value,’ he says. ‘It is a ‘fear asset’ which has historically risen at times of banking crisis, high inflation, collapsing currencies or sovereign government defaults when paper assets such as equities and bonds are tumbling.

‘Unlike most commodities, tracking the spot gold price is possible through an exchange traded vehicle which is collateralized by gold bullion held in a bank vault. Silver and Platinum can be bought in a similar manner – but timing an investment in gold is difficult,’ he warns.

‘Gold has no income stream and as such is difficult to value. Its main price driver often appears to be the degree of financial distress in economies and financial markets. As such, when bought it should be held over the long term, often proving its worth to a portfolio when least expected.’

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