Post by Erich on Jul 1, 2008 9:49:15 GMT -5
You, too, can be an oil speculator
Their impact on the price of oil and other commodities is exaggerated, but hedge funds and others are making a lot of money betting on higher prices. You can play the game, too.
By Tim Middleton
If Congress is against speculating in oil and other commodities, it's probably the best investment idea around.
And whereas ordinary investors until recently had lacked access to futures, options and other sophisticated tools that allow hedge and pension funds to leap into this volatile arena, exchange-traded funds have opened the doors for us.
It's even possible to speculate using money in your 401(k), if you have access to a mutual fund such as Pimco Commodity Real Return Strategy (PCRIX) or Pimco All Asset (PAAIX), a fund of funds that has nearly a third of its assets in the commodity fund.
Speculation made headlines last week when four oil analysts told a congressional committee the price of oil would be halved within one month if speculation in oil futures were eliminated.
One hitch: "That is all complete rubbish," says Tim Guinness, the manager of Guinness Atkinson Global Energy (GAGEX).
Like an overwhelming number of energy experts, Guinness believes a growing shortfall in supply will keep prices high for some time. The idea that speculators have raised the price of oil by half is also roundly dismissed.
Still, speculators are indeed making money -- lots of it -- as prices soar. It's tempting to try to get a piece of the action, and why not?
As Guinness notes, eliminating speculation would be impossible because the biggest abusers are commercial participants themselves, including oil drillers and refiners. "They speculate like hell," he says. Hedge funds indeed speculate, he says, but Congress' target includes investors -- you and me on a small scale and pension funds on a massive scale -- who are the least flighty, most long-term participants.
Reality seldom intrudes upon a politician's life, however, and a host of eager voices in Washington are clamoring for new regulations to make it difficult to make money on energy. So here are a baker's half-dozen ways to stick your thumb in Congress' unseeing eye -- and of course, get your share of the money rolling in.
And because oil isn't the only commodity Washington would love to screw up, the ideas go beyond the oil patch.
Speculation made simple
The price of oil is up because supply has fallen faster than demand. Non-OPEC production has been cut in half in some countries, including Russia and Nigeria, owing to local mayhem. And though demand in the developed world has begun to shrink, it has not in the developing world, much of which subsidizes energy to encourage industrialization.
None of that seems likely to change, but these days a lot of people see a bubble blowing up the prices of oil and other commodities. That means prices may come down before they go up again.
Are oil speculators are to blame for sky-high oil prices? Kyle Cooper, the director of research at IAF Advisors, and CNBC's Scott Cohn discuss the question.
Those are the sorts of short-term moves the speculators at hedge funds bet on. Rather than just owning stocks or actual commodities, they'll play with futures and options to stretch their dollars. They'll raise the size of their bets with leverage -- basically investing borrowed money -- and of course use short positions to bet prices will go down. All these moves add risk, particularly for those of us without the resources to play the markets 24/7.
For the rest of us, though, a set of relatively young exchange-traded funds have made speculating simple. ETFs trade just like stocks, and you can short them -- key advantages over mutual funds if you plan to play like a hedge fund. They provide access to futures and options as well.
Here are the key ones to consider:
The oil-patch plays
By no surprise, iPath S&P Crude Oil Total Return Index ETN (OIL, news, msgs) is the single hottest exchange-traded fund over the last year, ahead an amazing 116%, as of June 27. This is an exchange-traded note, or ETN, a variety of ETF that represents a kind of loan, rather than a portfolio of securities. Absent a credit default -- and the banking unit of Barclays (BCS, news, msgs), which backs these shares, has not been tarred by defaults -- it guarantees the return of an index, in this case the price of West Texas Intermediate, or sweet, crude oil, less its own expenses of 0.75%.
US Oil 12 Months (USL, news, msgs) is a true ETF that invests in a basket of monthly sweet-crude futures contracts that stretches forward for one year, smoothing out some of the technical volatility that adds to price swings as monthly contracts expire. Morningstar analyst Emiko Kurotsu recommends this fund over its better-known sibling, United States Oil Fund (USO, news, msgs), for this reason. The fund lacks a 12-month record, but this year it was ahead 38.9%. Expenses are 0.6%.
PowerShares DB Oil (DBO, news, msgs) also invests in sweet-crude futures and has expenses of only 0.5%. In the past year it has shot up 93.5%.
Beyond oil
PowerShares DB Agriculture (DBA, news, msgs) uses futures to invest in agricultural commodities such as corn and soybeans. This is a theme with its own dynamics, only some of which impinge on energy. Food prices are soaring, in part because corn is being used to produce ethanol. This ETF is ahead 59% in the past year.
If you don't want to pick individual commodities, you can target a larger universe with PowerShares DB Commodity Index (DBC, news, msgs), which owns futures on six widely traded commodities: crude oil, heating oil, gold, aluminum, corn and wheat. Ahead 77.3% in the past year, this ETF charges 0.83% in expenses.
iPath S&P GSCI Total Return Index (GSP, news, msgs) is an ETN that embraces all commodities in proportion to their market weighting. Energy accounts for 78% of the index, agriculture 11%, industrial metals 6%, livestock 3% and precious metals just under 2%. Expenses are 0.75%.
Funds for your 401(k)
Nearly every 401(k) contains a natural-resources investment option, but these portfolios typically own stocks in companies that produce things, as opposed to futures contracts in resources themselves.
Some plans may, however, offer either or both of those two noteworthy Pimco funds. You can also buy them directly, in load form from brokers or without loads (but with transaction fees, usually) from discount brokers.
Pimco Commodity Real Return Strategy seeks to track the return of the Dow Jones-AIG Commodity Index through the use of futures and derivatives. As is true with commodity ETFs, this strategy requires far less cash than the nominal value of the contracts. Pimco invests the excess cash in Treasury inflation-protected securities, or TIPS. The ETFs invest in money market instruments such as Treasury bills. The Pimco fund is ahead 59% in the last year.
If this fund is not available, Pimco All Asset owns it as well as other Pimco funds in a combination designed to outperform the Consumer Price Index. Despite their huge recent gains, the primary role commodities play in an investment portfolio is still inflation protection. The Pimco fund has generally accomplished this in a very conservative way. It uses TIPS as a proxy for inflation, and they are actually down this year, along with other bonds, even though inflation is spiking higher. This fund is up 5.7% and over the past five years has averaged annual returns of 7.8%.
The advantage of a mutual fund over an ETF in these markets is that the format is more comfortable for the everyday investor. ETNs carry a credit risk because ultimately they are simply the debt of the issuer; you don't own real assets like stocks, real estate or gold. Some ETFs have unusual tax implications that can require you to file a Schedule K-1 or face other tax wrinkles typical taxpayers never encounter.
Lastly, be careful. Speculators can make lots of money; they can also blow up. That's why long-term investing with a diversified portfolio is best for most of us. It's hard to resist the temptation of a commodities boom, but don't take big risks with money you can't afford to lose.
I happen to believe that commodities are floating in bubble land. The argument for a multiyear bull market in natural resources is compelling, but valuations are indeed being pushed up by, well, speculation. Their impact is exaggerated but, as I reported in a blog last week, Standard & Poor's thinks $120 oil is more sustainable than $140 oil.
Their impact on the price of oil and other commodities is exaggerated, but hedge funds and others are making a lot of money betting on higher prices. You can play the game, too.
By Tim Middleton
If Congress is against speculating in oil and other commodities, it's probably the best investment idea around.
And whereas ordinary investors until recently had lacked access to futures, options and other sophisticated tools that allow hedge and pension funds to leap into this volatile arena, exchange-traded funds have opened the doors for us.
It's even possible to speculate using money in your 401(k), if you have access to a mutual fund such as Pimco Commodity Real Return Strategy (PCRIX) or Pimco All Asset (PAAIX), a fund of funds that has nearly a third of its assets in the commodity fund.
Speculation made headlines last week when four oil analysts told a congressional committee the price of oil would be halved within one month if speculation in oil futures were eliminated.
One hitch: "That is all complete rubbish," says Tim Guinness, the manager of Guinness Atkinson Global Energy (GAGEX).
Like an overwhelming number of energy experts, Guinness believes a growing shortfall in supply will keep prices high for some time. The idea that speculators have raised the price of oil by half is also roundly dismissed.
Still, speculators are indeed making money -- lots of it -- as prices soar. It's tempting to try to get a piece of the action, and why not?
As Guinness notes, eliminating speculation would be impossible because the biggest abusers are commercial participants themselves, including oil drillers and refiners. "They speculate like hell," he says. Hedge funds indeed speculate, he says, but Congress' target includes investors -- you and me on a small scale and pension funds on a massive scale -- who are the least flighty, most long-term participants.
Reality seldom intrudes upon a politician's life, however, and a host of eager voices in Washington are clamoring for new regulations to make it difficult to make money on energy. So here are a baker's half-dozen ways to stick your thumb in Congress' unseeing eye -- and of course, get your share of the money rolling in.
And because oil isn't the only commodity Washington would love to screw up, the ideas go beyond the oil patch.
Speculation made simple
The price of oil is up because supply has fallen faster than demand. Non-OPEC production has been cut in half in some countries, including Russia and Nigeria, owing to local mayhem. And though demand in the developed world has begun to shrink, it has not in the developing world, much of which subsidizes energy to encourage industrialization.
None of that seems likely to change, but these days a lot of people see a bubble blowing up the prices of oil and other commodities. That means prices may come down before they go up again.
Are oil speculators are to blame for sky-high oil prices? Kyle Cooper, the director of research at IAF Advisors, and CNBC's Scott Cohn discuss the question.
Those are the sorts of short-term moves the speculators at hedge funds bet on. Rather than just owning stocks or actual commodities, they'll play with futures and options to stretch their dollars. They'll raise the size of their bets with leverage -- basically investing borrowed money -- and of course use short positions to bet prices will go down. All these moves add risk, particularly for those of us without the resources to play the markets 24/7.
For the rest of us, though, a set of relatively young exchange-traded funds have made speculating simple. ETFs trade just like stocks, and you can short them -- key advantages over mutual funds if you plan to play like a hedge fund. They provide access to futures and options as well.
Here are the key ones to consider:
The oil-patch plays
By no surprise, iPath S&P Crude Oil Total Return Index ETN (OIL, news, msgs) is the single hottest exchange-traded fund over the last year, ahead an amazing 116%, as of June 27. This is an exchange-traded note, or ETN, a variety of ETF that represents a kind of loan, rather than a portfolio of securities. Absent a credit default -- and the banking unit of Barclays (BCS, news, msgs), which backs these shares, has not been tarred by defaults -- it guarantees the return of an index, in this case the price of West Texas Intermediate, or sweet, crude oil, less its own expenses of 0.75%.
US Oil 12 Months (USL, news, msgs) is a true ETF that invests in a basket of monthly sweet-crude futures contracts that stretches forward for one year, smoothing out some of the technical volatility that adds to price swings as monthly contracts expire. Morningstar analyst Emiko Kurotsu recommends this fund over its better-known sibling, United States Oil Fund (USO, news, msgs), for this reason. The fund lacks a 12-month record, but this year it was ahead 38.9%. Expenses are 0.6%.
PowerShares DB Oil (DBO, news, msgs) also invests in sweet-crude futures and has expenses of only 0.5%. In the past year it has shot up 93.5%.
Beyond oil
PowerShares DB Agriculture (DBA, news, msgs) uses futures to invest in agricultural commodities such as corn and soybeans. This is a theme with its own dynamics, only some of which impinge on energy. Food prices are soaring, in part because corn is being used to produce ethanol. This ETF is ahead 59% in the past year.
If you don't want to pick individual commodities, you can target a larger universe with PowerShares DB Commodity Index (DBC, news, msgs), which owns futures on six widely traded commodities: crude oil, heating oil, gold, aluminum, corn and wheat. Ahead 77.3% in the past year, this ETF charges 0.83% in expenses.
iPath S&P GSCI Total Return Index (GSP, news, msgs) is an ETN that embraces all commodities in proportion to their market weighting. Energy accounts for 78% of the index, agriculture 11%, industrial metals 6%, livestock 3% and precious metals just under 2%. Expenses are 0.75%.
Funds for your 401(k)
Nearly every 401(k) contains a natural-resources investment option, but these portfolios typically own stocks in companies that produce things, as opposed to futures contracts in resources themselves.
Some plans may, however, offer either or both of those two noteworthy Pimco funds. You can also buy them directly, in load form from brokers or without loads (but with transaction fees, usually) from discount brokers.
Pimco Commodity Real Return Strategy seeks to track the return of the Dow Jones-AIG Commodity Index through the use of futures and derivatives. As is true with commodity ETFs, this strategy requires far less cash than the nominal value of the contracts. Pimco invests the excess cash in Treasury inflation-protected securities, or TIPS. The ETFs invest in money market instruments such as Treasury bills. The Pimco fund is ahead 59% in the last year.
If this fund is not available, Pimco All Asset owns it as well as other Pimco funds in a combination designed to outperform the Consumer Price Index. Despite their huge recent gains, the primary role commodities play in an investment portfolio is still inflation protection. The Pimco fund has generally accomplished this in a very conservative way. It uses TIPS as a proxy for inflation, and they are actually down this year, along with other bonds, even though inflation is spiking higher. This fund is up 5.7% and over the past five years has averaged annual returns of 7.8%.
The advantage of a mutual fund over an ETF in these markets is that the format is more comfortable for the everyday investor. ETNs carry a credit risk because ultimately they are simply the debt of the issuer; you don't own real assets like stocks, real estate or gold. Some ETFs have unusual tax implications that can require you to file a Schedule K-1 or face other tax wrinkles typical taxpayers never encounter.
Lastly, be careful. Speculators can make lots of money; they can also blow up. That's why long-term investing with a diversified portfolio is best for most of us. It's hard to resist the temptation of a commodities boom, but don't take big risks with money you can't afford to lose.
I happen to believe that commodities are floating in bubble land. The argument for a multiyear bull market in natural resources is compelling, but valuations are indeed being pushed up by, well, speculation. Their impact is exaggerated but, as I reported in a blog last week, Standard & Poor's thinks $120 oil is more sustainable than $140 oil.