Commodity investment is getting physical. A host of companies are working on products that give investors physical exposure to copper, aluminium and other base metals, spurred on by the success of similar investment vehicles in precious metals markets.
The new products – exchange-traded funds (ETFs) that hold physical metal – are set to open the markets to mainstream investors for the first time. But, if successful, they could also revolutionise the fundamental drivers of the markets by allowing investors to hoard metal. “There is no question that ETFs will create a new category of physical demand for the market,” says Mike Frawley, global head of metals at Newedge, a brokerage.
The building momentum behind the launch of the new products comes as base metals prices have risen sharply from the depths of the financial crisis, buoyed by resurgent demand from China and other emerging economies.
For metals such as copper and tin, with demand already outstripping supply, a fresh source of demand from investors could send prices soaring from current record levels.
Max Layton, metals analyst at Macquarie, says that over the next few months, the prospective launch of copper ETFs is likely to determine whether prices rise above $9,000 a tonne for the first time. “That physical ETF working and being successful – that’s the difference between $8,500 copper and $10,000 copper,” he says.
Bankers say the drive for physical base metal ETFs comes from investors seeking exposure to a “hard asset” amid ever-increasing concerns about the debasement of paper currencies. Equally, and especially in the US, the products are being requested by equity fund managers, who have limited ability to gain exposure to base metals via the US equities markets.
The first movers are JPMorgan and BlackRock iShares, which have separately begun the process of launching physical copper ETFs in the US. Elsewhere, ETF Securities, a London-based ETF specialist, has announced its intention to launch ETFs in all the LME-traded base metals on the London Stock Exchange. And Credit Suisse and Glencore, the world’s largest commodity trading house, have applied to launch a physical aluminium investment product in Switzerland.
For all the hype, however, there is no certainty that the ETFs will get off the ground. The regulatory process could take several months; indeed, the Credit Suisse/Glencore product has already been held up by the Swiss regulator. In the UK, the Financial Services Authority has received a complaint about the new products’ potential to distort the markets.
Moreover, the preliminary prospectus filed by JPMorgan concedes that: “The trust, as it grows, may have an impact on the supply and demand of copper that ultimately may affect the price of the shares in a manner unrelated to other factors affecting the global markets for copper.”
However, the potential effect of the new ETFs on prices is unlikely to be the main concern for the regulators. The preliminary prospectuses filed by JPMorgan and BlackRock state explicitly that their copper ETFs will not be regulated by the US commodities regulator, the Commodity Futures Trading Commission – instead they will be overseen by the Securities and Exchange Commission. In Europe, the FSA stresses that its role does not include regulating prices.
Instead, in the US, the UK and Switzerland alike, regulators are likely to focus on investor protection – with the key issue being whether the products are being fairly marketed.
Even if the ETFs are given a green light by regulators, sceptics believe they may fail to garner significant investor interest. Some argue the products are motivated more by the desire for banks to demonstrate their financial wizardry than by real investor demand.
The main drawback from an investor’s point of view is likely to be relatively high costs. Jean Bourlot, head of commodities at UBS, says: “Storage and insurance costs for base metals – aluminium in particular – are much higher than precious metals, which may be seen as a deterrent.”
Neither JPMorgan nor BlackRock has provided details of the costs for their proposed copper ETFs, but bankers say they are aiming significantly to undershoot the annual fees traditionally charged by hedge fund managers – 2 per cent a year plus 20 per cent of profits. Specialists believe that with annual charges of about 1.5 per cent, the ETFs could gain traction among investors.
On the flip side, what may be expensive for investors is likely to be a boon for banks and brokers. JPMorgan, through its Henry Bath subsidiary, will reap handsome warehousing fees and Goldman Sachs, through its Metro subsidiary, is to provide the warehousing service for the BlackRock product. Moreover, dealers will have a new opportunity to arbitrage between the market price of metal and the price of the ETF shares.
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