Fed Chair Janet Yellen and the rest of the Federal Open Markets Committee (FOMC) are walking
a fine line right now between being overly accommodative and choking off the recovery, but even we were surprised at the ultra-dovish tone she adopted during a March 29 speech that helped to further weaken the dollar.
The weaker dollar should act like a commodities defibrillator, but traders shouldn’t be so quick to dismiss the role of much-maligned commodity exchange-traded funds (ETF) that just had their best quarter in years, with billions in investor capital returning to the sector (see “Commodity flows”). While the S&P 500 struggled to close out Q1 in the black, some commodities recorded double digit gains. However, before rushing out to load up on soybean and lean hog exposure, consider first where most of the money is going.
When it comes to fund flows, the story is less about broad-based funds and more about precious metals: Gold and silver funds have absolutely dominated. We track six broad categories of commodity funds and of the approximately $9.3 billion in new assets in Q1, more than 90% went to precious metals funds. Investor obsession with the supposed defensive qualities of gold means that it will always capture the most headlines, despite serving more as a currency than a commodity. Gold continues to dominate because of how funds like the SPDR Gold Shares (GLD) or the iShares Silver Trust (SLV) are structured.
For most people, a commodity fund probably conjures up images of silos full of grain instead of a collection of futures contracts, which mean they aren’t ready to understand that almost all commodities ETFs suffer from one of two serious problems. The first applies to commodity-specific funds like the United States Oil Fund (USO), which is designed to track the daily movements in the price of WTI Crude. USO’s focus is on buying the nearest dated contract which needs to be rolled at the end of each month. That roll yield takes a heavy toll on performance when the crude oil market is in contango like it is now, which eventually will lead to serious tracking errors between the fund and the commodity. In the first quarter, the spot price of WTI was up above 2.8%, while USO was down 11.82%.
The second major problem with broad commodity funds is they often are linked to indexes with heavy energy exposure. There are valid reasons for this, but while crude tends to dominate, users are not necessarily getting broad exposure to the commodities universe. The biggest—the PowerShares DB Commodity Index Tracking Fund (DBC)—has nearly 50% of its portfolio in energy futures from Brent Crude through natural gas, so no wonder it picked up a mere $1.8 million in new assets in the first quarter.
On the other hand, precious metals funds like GLD and SLV are what people imagine them to be: Paper claims on large stockpiles of gold and silver that offer high correlation and low tracking error, meaning the only issue that investors need to debate is when the Fed will raise rates.