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Commodity ETFs

Precious metals have taken off so far this year both in terms of popularity and performance. Investors have scooped up ETFs that target products such as gold and silver while also dipping their toes into platinum and palladium-based funds as well. While these metals have stolen the show, many are also beginning to take a closer look at the group’s industrial-focused cousins as well for investment. Copper, for example, is far more useful in everyday applications than many precious metals, as the red metal finds its way into a number of products ranging from electrical wiring to plumbing and roofing. This ensures that copper remains a good proxy for global economy growth and that the metal will remain an important product for decades to come.

In light of this, many investors have looked towards the exchange traded market for options in the space. As of late, the options were minimal to say the least as only two funds offered direct, exclusive exposure to the metal. The dominant player in the space is the iPath Dow Jones AIG Copper Total Return Sub-Index ETN (JJC - ETF report) which has just over $130 million in assets. The fund tracks a single futures contract in copper, giving investors direct exposure to the important metal while simultaneously collateralizing the investment with a purchase of short-term U.S. Treasury debt. The only other product in the space is the upstart from iPath, the Pure Beta Copper ETN (CUPM - ETF report) which debuted in April of this year. The fund has so far failed to capture assets despite its relatively interesting methodology which seeks to roll into one of a number of futures contracts with varying expiration dates, as selected using the Barclays Capital Pure Beta Series 2 Methodology.

Beyond these two ETNs, however, options have been hard to come by. A physically-backed option, much like we have in the precious metals market, still eludes investors thanks to the low mass-value ratio inherent in copper. This low ratio, which makes copper worth but a fraction of its precious metal cousins, makes the cost of storing the metal in warehouses prohibitive to issuers, at least at the current juncture. Nevertheless, innovation still abounds in the space with the recent release of the first copper ETF, the United States Copper Index Fund (CPER - ETF report).

This brand new fund seeks to reflect the daily changes in percentage terms of the Copper Index, less CPER’s expenses. This benchmark is designed to reflect the performance of the investment returns from a portfolio of copper futures contracts fully collateralized with 3-month U.S. Treasury Bills. Currently, exposure is spread across three different maturities with assets going towards March, April, and December 2012 contracts. However, fees are a little higher than the other copper funds with expenses coming in at 0.95% compared to 0.75% for both of the other products.

Key Differences

Beyond the expense differential, the methodologies may sound similar but there are actually a number of key differences that investors should be aware of. First, and arguably the most important difference, is that CPER is an ETF and not an ETN. This means that while CPER has tracking error and can potentially deviate from its benchmark, the fund does not have any credit risk, unlike its ETN counterparts. Furthermore, CPER also holds more contracts than either of the more established funds in the space, spreading exposure across the curve in a way that both CUPM and JJC do not. However, the downside is that CPER, thanks to this structure, is treated as a partnership for U.S. tax purposes. This means that investors will have to file a K-1 come tax time and they may also see differences in terms of both long and short term capital gains rates, but obviously this will depend on an individual investor’s situation.

Which To Pick?

Each of the copper products available to investors has their own pros and cons that must be evaluated before making a purchase. While CPER is more expensive than its counterparts, its more varied exposure, coupled with its ETF structure, may be appealing to some investors. On the other hand, the minor tax hassle of filing out the K-1, along with the 20 extra basis points in expenses, could be enough to push some cost-conscious investors to the ETNs, it really depends on the individual situation.

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