Corporate Bond ETFs and Self-Fulfilling Prophecies

Lou Gehrig famously called himself "the luckiest man on the face of the earth," but I respectfully disagree with the Iron Horse. The luckiest people have to be those corporate executives whose stock pops higher because it just moved into theS&P 500 or because of some artifact in the annual "Russell hustle" surrounding the reconstitution of those indices and whose stock options soar as a result. If your stock benefited because it grew into that slot, fine. But if it moved up in the ranks because others were taken out and shot, well, you are just lucky.

The ETF Effect

This inclusion effect worked with the introduction of commodity exchange-traded funds such as the SPDR Gold Trust (GLD - commentary - Trade Now) in November 2004. The ETF holds gold bullion to back its shares, and with more than 1,100 metric tons in the vaults, it now ranks among the top 10 holders of bullion in the world.

As imitation is both the sincerest form of flattery and the most common business model on Wall Street, ETF creators began to plan for other ETFs backed by physical commodities. None were as neat as gold, and some such as the United States Oil Fund (USO - commentary - Trade Now) were both badly designed and ultimately poor investments despite their popularity, as predicted here in April 2006.

The proposal for a silver ETF, the iShares Silver Trust (SLV - commentary - Trade Now), ran into a buzz saw of protest from the Silver Users Association, which pointed out that while gold is mined to be reburied in vaults, silver has numerous industrial uses. Anticipation of the ETF's ultimate approval to launch in April 2006 led to a hoarding effect in silver and a large jump in its price relative to gold.

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Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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