Small Investors Affected by Big ETF Push

August 25, 2009 8:15 am

There is trouble brewing in the world of commodity ETFs. It seems that the little guy is overwhelming the system. Yeah right…

Can you believe this? The CFTC is looking to limit the abilities of ETFs to buy into certain commodity markets as they are seeming to artificially hold up pricing. If that is true, why has the natural gas ETF (UNG) been unable to do anything for the price of natural gas, now close to a 7 year low?

What will happen if the CFTC removes the ability for individuals, pensions, money managers and advisers to efficiently invest in the commodities? Will it collapse markets? Will it restore “fair and efficient” order to an area that has been heavily manipulated for years. No way!

The CFTC needs to refocus their focus to the players who have pumped oil up towards $75 without any fundamental basis. They need to look at the players that move natural gas by 5%, up and down in any given day. They need to stop “spinning” as has been admitted by Bart Chilton in a recent CNBC interview. Yes SPINNING the idea that $145 oil was based on fundamentals and not speculative activity. Are they spinning now?

From Bloomberg:
By BRIAN BASKIN

U.S. regulators have begun targeting the big-time speculators suspected of artificially inflating prices for oil, natural gas and gold. Turns out some of the big guys happen to be small fry.

Exchange-traded funds, which have become popular as one of the few avenues for small investors to gain direct exposure to commodity futures, are a top target in the Commodity Futures Trading Commission’s drive to rein in speculation in oil markets. The CFTC’s moves reverse a trend in market innovation that allowed almost anyone to bet on the direction of energy prices along with the likes of Goldman Sachs Group Inc.

And bet they did. Commodity ETFs came into existence in 2003 just as the boom in commodities prices was getting under way. They have ballooned to hold $59.3 billion in assets as of July, according to the National Stock Exchange.

Since the beginning of the year, $22.1 billion has flowed into these funds compared with inflows of $7.3 billion during the same period in 2008. Almost half of the new money that has come in this year has been directed at the largest commodity ETF, which buys gold, amid worries about inflation.

The funds pool money from investors to make one-way bets, usually on rising prices. Some say this causes runaway buying that ignores bearish signs that more knowledgeable investors and commercial hedgers usually heed. The CFTC has said its priority is to protect end consumers of commodities, who would benefit from lower prices that regulators and lawmakers say would result from limits on speculation.

Cutting out individual investors isn’t the goal, said Bart Chilton, a CFTC commissioner, in an email. “The Commission has never said ‘You aren’t tall enough to ride,’ ” Mr. Chilton said. “I don’t want to limit liquidity, but above all else, I want to ensure that prices for consumers are fair and that there is no manipulation — intentional or otherwise.”

Yet the coming regulatory changes are already reshaping this popular corner of the investing world for small investors.

Limiting the size of ETFs will result in higher costs for investors, ranging from individuals to banks and hedge funds with multimillion-dollar positions, because legal and operational costs have to be spread out over a fewer number of shares. It also would render the instruments less desirable, because prices of the shares of closed funds tend to deviate from price moves in the underlying commodity.

Already, U.S. Natural Gas Fund, or UNG, is trading at a 16% premium to gas futures because investors are willing to pay extra for the ability to expose their portfolios to the commodity. The PowerShares DB Oil Fund, which tracks crude futures with no share limit, traded 0.3% above its benchmark commodity Thursday.

This past week, UNG confirmed it wouldn’t issue more new shares and said it owns about a fifth of certain benchmark gas contracts, potentially higher than the new limits will allow. Deutsche Bank AG’s PowerShares DB Crude Oil Double Long ETN, or exchange-traded note, an ETF-like security similar to a bond, followed suit on Tuesday.

The CFTC said Wednesday that it withdrew exemptions it had granted two Deutsche Bank commodity ETFs years ago on speculative limits on corn and wheat contracts. On Friday, Barclays PLC said it would temporarily suspend any new share issues for its natural-gas ETN.
[John Hyland]

John Hyland

“What you’re really saying is the only people who should be allowed to trade crude oil are oil companies and Morgan Stanley,” John Hyland, chief investment officer for the company that manages UNG and the largest oil ETF, told CFTC commissioners in a hearing earlier this month.

He defended his funds as existing “to serve people who otherwise would find it difficult or undesirable to themselves buy futures.”

Goldman Sachs and Morgan Stanley are two of the banks seen as most active in commodities trading. They also are likely to feel the impact from the new rules.

Mr. Hyland claims between 500,000 and 600,000 investors in his U.S. Oil Fund and UNG, both of which have come under scrutiny due their sheer size.

Vernon Reaser is one of those investors and says he is frustrated that regulators’ actions are essentially discouraging him from accessing commodities markets. “I’m American and am all for stability,” said the 43-year-old small-business owner in Houston. While small investors tend to shy away from futures because of high costs and margin requirements, without ETFs, “there’s nothing left but futures,” Mr. Reaser said.

Smaller funds could spring up to take in investors prevented from joining funds that have run afoul of federal limits, but at a price.
[etf]

“If they give up on scale and have to drive their expense ratios up … that just makes it a higher bar for the fund to jump to generate positive returns,” said Mark Willoughby, a financial adviser with Modera Wealth Management in Old Tappan, N.J.

Mr. Willoughby recommends that most clients invest 4% to 7% of their holdings in commodities, but said his firm is debating the best ways to do so in light of recent developments.

Investors shut out of ETFs would still have a few ways to track commodity prices, such as a major oil company like Exxon Mobil Corp. Shares of such companies usually, but not always, move with energy prices.
—Ian Salisbury and Anna Raff contributed to this article.

Write to Brian Baskin at brian.baskin@dowjones.com

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