Tuesday, August 25, 2009

The great commodity ETF unwind. And: "That commodity ETF effect, in grains"

I had meant to link to the grains post last week and forgot. Here are two from FT Alphaville:
Aug. 21

There’s been a spate of commotion this week in the world of commodity ETFs, or ETPs (exchange traded products) as they are fast becoming known.

It comes in the shape of a CFTC ruling that resulted in two Deutsche Bank PowerShares commodity funds, with a total of $5.8bn of funds under management, no longer being eligible for position-limit exemptions in wheat and corn. While this sort of action wouldn’t surprise followers of the ETP-effect story in energy markets, the agricultural markets have been caught a touch unaware by the move.

As Dennis Gartman, of the Gartman Letter, noted in his Thursday report most of the market is still trying to ascertain what it means and what the longstanding implications may be:

Finally, regarding grains, the CFTC surprised everyone mid-day in the trading session yesterday by rescinding its previous actions against two of the larger exchange traded funds in the grain business. The long term implications of the decision are not yet known, but the short term implications were that long positions in wheat were liquidated by the funds.

There’s no doubt the grain markets are a completely different animal to the energy markets. The influence of passive exchange-traded funds on contracts, as a result, is much greater due to the market’s much lower liquidity levels.

Now, it could be that the CFTC is trying to act pre-emptively, in so much as after clamping down on the USO in the oil markets, and the UNG fund in the natural gas market, energy arbitrageurs might be tempted to move into the wheat and corn — whose markets are also in contango — to trade the ethanol link.

Given the degree to which commodity ETPs took off in the last few years, any substantial liquidation on the back of enforced regulatory rulings could have a notable impact on prices....MORE

Aug. 25

What began with the UNG, appears to be spreading very quickly across the entire commodity exchange-traded product space. Almost every day another fund is announcing the suspension of new share issues – at the risk of destabilising its tracking record, we might add — on fears the CFTC will soon act to restrict fund positions across commodity futures.

Barclays Global Investors’s iShares S&P GSCI ETF, which tracks the S&P GSCI Total Return Index with investments in metals, energy, agriculture and livestock futures, was the latest to join the list of affected funds on Monday this week.

FT Alphaville has discussed the issues leading up to the current clampdown at length, nevertheless, we still find the following assessment by Morning Star’s Bradley Kay particularly well-rounded and worth recounting on account of doing such a good job of putting the situation in context. As Kay explains:

Investors who followed the dramatic growth of United States Oil at the end of 2008 and beginning of 2009 probably remember how it took up a vast share of the U.S. oil futures market on the New York Mercantile Exchange, or NYMEX. Without CFTC scrutiny, the fund never had to stop issuing shares, but it did produce tremendous distortions in the market as other traders front-ran its massive trades and prevented it from benefiting as the spot oil price began to rise. As assets fell, so did the contango produced by the USO’s holdings, and the fund finally began to move with the oil prices.

The bigger and badder sequel to USO began in the Spring of 2009 as money flooded into United States Natural Gas. Compared with crude oil, which has one of the largest and most liquid commodity futures markets in the world, natural gas is a sleepy corner of the market. Assets in UNG swelled to more than $4 billion by July 2009, by which point the fund held nearly every long position in the front-month contract of the NYMEX natural gas contract, as well as huge positions in the equivalent contract on the London-based Intercontinental Exchange, and substantial swap contracts with major broker-dealers. UNG was not the 800-pound gorilla of the natural gas market–it was King Kong....MORE