Shop Around for Commodity Funds

The other day I wrote about a new family of exchange-traded notes from a company called Elements that use indices created by legendary commodities investor Jimmy Rogers.

But anyone looking to get exposure to this asset class has many new exchange-traded products to choose from, so you should not buy from one provider without at least looking at the others.

In that article I made a reference to one of several new commodity iPath ETNs from Barclays Global, a unit of Barclays PLC ( BCS) that also sponsors the iShares brand of exchange-traded funds. Barclays has recently expanded its lineup of commodities products in a meaningful way, adding several products that track narrower sectors of the market:

  • iPath DJ AIG Agriculture Total Return Sub Index (JJA)
  • iPath DJ AIG Copper Total Return Sub Index (JJC)
  • iPath DJ AIG Grains Total Return Sub Index (JJG)
  • iPath DJ AIG Energy Total Return Sub Index (JJE)
  • iPath DJ AIG Industrial Metals Total Return Sub Index (JJM)
  • iPath DJ AIG Livestock Total Return Sub Index (COW)
  • iPath DJ AIG Natural Gas Total Return Sub Index (GAZ)
  • iPath DJ AIG Nickel Total Return Sub Index (JJN)

All eight of these ETNs are carved out of the older, broader iPath DJ AIG Commodity Index Total Return ETN ( DJP). As ETNs, or exchange-traded notes, they are debt obligations of Barclays Global. That means investors do not actually own the various commodities; instead Barclays is committing to investors that the products will mimic their intended indices, less the 0.75% expense ratio.

Some of the new iPath commodity ETNs are more narrowly focused than their Elements counterparts; JJG tracks just three grains compared with 20 agricultural products in the Elements Linked to Rogers International Commodity Index Agriculture Total Return ( RJA).

I made the case for agriculture and so, by extension, grains (in the case of JJG, the fund is allocated 42.6% to soybeans, 35.8% to wheat and 21.6% to corn) and, to some extent, livestock (COW, for instance, consists of 67.9% cattle and 32.1% lean hogs), in last week's article. These sectors have underperformed energy and metals in the past, but that doesn't mean they will in the future.

Likewise, there are iPath ETNs tracking individual metals (nickel and copper), whereas the corresponding Elements ETN provides exposure to 10 metals.

The three iPath metals ETNs are very interesting. Things like copper and nickel tend to be a good way to play the early part of the economic cycle. The basic idea is that as an economy starts to turn around, early (manufacturing) stage metals like nickel and copper start to get purchased and consumed first. Phelps Dodge stock used to be a similar play.

The insatiable demand for these and other types of metal, most notably from China, may have temporarily altered their cyclical nature. Regardless of what we hear about the Chinese stock market and how overvalued it is, there is a massive infrastructure build-up in China. GDP has been growing by double digits and the hot growth is likely to persist for a while.

Even if there is a huge stock market correction, demand for these metals is unlikely to be derailed in such a manner as to bring the commodity story to an end. The building up and out in China is bigger than the stock market. Obviously if you disagree you would want to avoid these metals.

I am not a big fan of owning commodities from the energy complex. They tend to be very volatile even as commodities go. The reason I own commodities is to offer diversification for an equity-based portfolio while lowering overall volatility. I think achieving this with energy commodities is difficult and would rather own dividend-paying oil stocks instead of oil. Obviously others will view this differently.

There are plenty of people who will tell you not to own any commodities, that they are merely for speculation. That can be true, but, of course, one can speculate with a total market index fund, too. Any product is as speculative as you want to make it.

The broad-based fund from which the new narrower funds were spawned, DJP, has a correlation of 0.22 to the S&P 500. The historical correlations for the eight new subindex funds range from negative 0.23 to positive 0.35. If that can persist going forward that would fit the bill, as far as I am concerned, for an asset with low correlation.

As I mentioned in last week's article, I favor allocating no more than 5% to commodities. There are plenty of well-reasoned studies that make the case for a bigger allocation, but I believe it's too tempting for investors who are new to the space to look at the great returns of the last few years and simply add more exposure -- and potential volatility -- than they can really tolerate. If the commodity boom lasts another 10 years, a 5% weight will still benefit handsomely, but if commodities implode, a small allocation will only result in a performance lag.

At the time of publication, Nusbaum did not have positions in any of the securities discussed in this article, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.

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