FTFM Exchange traded commodities are beginning to attract the attention of investors just as most commodities, such as crude oil, copper, wheat or gold, experience the strongest and longest bull market in a generation.
Commodities prices have surged, driven by strong demand from emerging countries, led by China and India, lagging supply after years of low prices caused under-investment and, in some cases, fresh geopolitical tensions. Crude oil prices, for example, have jumped from the 1990s average of $18 to $90 a barrel in 2007.
Exchange traded commodities (ETCs) are listed securities backed by a commodity - either physical commodities, such as gold bars, or commodity futures, such as crude oil futures contracts traded on the New York Mercantile Exchange.
The industry says the ETC allows ordinary investors to access the commodities asset class through regular brokerage accounts, opening a new asset class to managers that in the past did not want to deal with the difficulties of investing in futures or physical commodities or, because of regulations, were barred from the asset class.
Jim Ross, senior managing director at State Street Global Advisors in New York, says some investors were in the past not allocating their portfolios to commodities because there was no easy way to gain exposure.
"The exchange traded commodities have helped to democratise the commodities investment," says Mr Ross.
Previously, the only option for such investors to gain commodities exposure was to invest in mining or energy companies' shares or their debt.
But that left them exposed to corporate risks on top of the movements in commodities prices.
The ETC's development has largely benefited from the same academic research that pushed institutional investors, such as pension funds and insurance companies, into the nascent commodities asset class: negative correlation to equities and bonds.
Commodities, in particular crude oil, also act as a hedge against inflation, which can erode company profits and share prices. Inflation typically also means higher interest rates, which often leads to lower prices of government and corporate bonds.
In spite of their recent popularity, globally exchange traded commodities make up only a small percentage of the total invested in exchange traded funds. Nik Bienkowski, head of listings and research at ETF Securities in London, estimates ETC assets at about $28bn, or only 4 per cent of the $700bn invested in ETFs.
ETCs are also relatively young compared with other exchange traded products. The first ETC developed, the Gold ETC, was launched in 2003, 10 years after the first equity ETF was created. Gold still represents about 65 per cent of the total investment in ETCs, according to industry estimates.
Mr Bienkowski says the development of ETCs has opened up some of the oldest markets in the world to ordinary investors.
They have taken full advantage of the opportunity with democratisation of commodity investment translating into a tremendous growth of assets.
Between 2005 and 2006, global ETC assets rose tenfold while the number of products on offer has jumped from 10 to 80. And at current growth rates, global ETC assets are likely to exceed $45bn by December 2008.
The growth in investment has been parallel to a widening in the investors accessing the new asset class.
Mr Ross says investment in ETCs has found its way downstream from the initial institutional investors, such as pension funds, to sophisticated financial advisers and high net worth individuals and, recently, even to retail investors.
The range of products has also widened, particularly in the last year. From the initial Gold ETC the industry has developed an array of new ETCs to gain exposure to oil and energy commodities, base and precious metals, agricultural and livestock commodities and also commodities indices, such as the popular DJ-AIG index.
Recently, the industry has also developed new ETCs that invest further along the futures curve, for example in contracts deliverable six months, a year or two years in the future.
That is a distinctive feature compared with existing oil ETCs, which track only front-month futures prices, and allows investors to avoid losses when the markets are in contango - futures prices higher than spot contracts.
"Products are going to continue evolving, with a move towards smarter indices and investing out of the front of the curve," says Mr Ross.
