Copper ETFs, funds of a different kind?
Looking at the historical performance of copper ETFs, why is the proposed launch of 2 more generating so much opposition among copper fabricators, Andy Home investigates.
Posted: Wednesday , 05 Dec 2012
LONDON (Reuters) -
Looking at the historical performance of ETF Securities' physically backed copper fund, you might wonder why the proposed launch of two more is generating so much opposition among copper fabricators.
The UK specialist in exchange-traded funds (ETF) was the first to extend what is now a major precious metals investment product into the base metals arena.
It launched three ETFs backed by physical metal - copper, nickel and tin - in December 2010. In May 2011 the suite was extended to the other three base metals traded on the London Metal Exchange (LME): aluminium, lead and zinc.
Between them, the six products currently hold 3,179 tonnes of LME-registered metal.
Copper accounts for 1,950 tonnes of that total.
It has always been the most successful of the six in terms of metal held, which with this sort of fund reflects the amount of money invested.
That shouldn't be surprising since copper has long enjoyed the highest investor profile among all the LME-traded metals.
"Dr Copper" has historically been viewed as an investment surrogate for the world's manufacturing sector, thanks to its usage across a wide spectrum of industrial applications.
Yet the current holding is only a fraction of the 249,025 tonnes of metal sitting in the LME warehouse system.
And even at its peak, 6,875 tonnes over the March-April 2012 period, it still amounted to only a fraction of LME stocks, let alone global stocks.
So why all the fuss about JP Morgan's Physical Copper Trust and Blackrock's iShares Copper Trust? *********************************************************** Link to the SEC report:Link to ETF Securities' physical copper ETF page, with holdings of LME metals:***********************************************************
APPLES AND PEARS?
The U.S. Securities and Exchange Commission (SEC) has been charged with answering that question before it signs off on the products' launch.
Its conclusion came in two parts.
The first, highly counter-intuitive, was that there was no statistical correlation between LME stocks of copper and price, although there was between what the SEC termed as "total" copper stocks and price.
That conclusion was based on oversimplistic analysis and an inability to factor in the most important "total" stocks development of the last few years - the gravitation of free copper units towards Shanghai’s bonded warehouse zone.
The second conclusion was that there has been no correlation between investment flows into other metal-backed ETFs and the price of those metals.
The SEC used the same regression analysis as performed on the LME price/stocks relationship, looking for statistical linkage between asset flows into the most successful ETFs and subsequent price changes in the underlying metals.
The problem, of course, is that the most successful physical ETFs have all been in the precious metals sector.
Gold, silver, platinum and palladium attracted investors' attention long before the launch of retail-oriented ETFs in the 1990s. Indeed, gold has arguably done so since the dawn of time, or at least since mankind first worked out how to extract the stuff.
None, not even platinum and palladium with their linkage to the automotive sector, can be said to be an industrial metal on the scale of copper.
Physical precious metals ETFs may have facilitated greater investment flows from "the man in the street" but may in part only have shifted existing investor appetite away from traditional products such as bars, coins and jewellery.
Comparing investment influence on price between precious metals and an industrial metal such as copper seems a classic case of comparing "apples with pears".
Well at least the SEC had one industrial metal ETF it could look at: ETF Securities' physical copper fund.
Which brings us back to the question above. With just 1,950 tonnes of physical copper removed from the market, what's all the fuss about?
FUNDS OF A DIFFERENT KIND?
The fuss is all about the proposed size of the two funds.
JP Morgan's application envisages a fund holding up to 60,000 tonnes. Blackrock's iShares application, registered just days later in 2010, outdid that with a potential size of 120,000 tonnes.
There's more than a hint of one-upmanship going on in these listings, particularly Blackrock's neat "I'll double that" proposition.
But the key question here is, what makes these two companies think that their products are going to be any more successful than ETF Securities' London product?
If it's just machismo, then copper fabricators probably have little to worry about.
But could it be that JP Morgan and Blackrock are targeting a completely different sort of investor?
The proposed size of each fund suggests so.
So does the fact that neither is following ETF Securities in offering a spectrum of copper ETFs. Its physically backed copper fund is complemented by a (long) Copper ETF, a Short Copper ETF and a Leveraged Copper ETF, all based on the DJ-UBS Copper Sub-Index, itself based on the futures market.
From this gamut of investment options, the physical metal fund is the one most suited to when the copper market is in contango, minimising as it does the cost of a futures position being rolled forward.
AN INVESTOR OF A DIFFERENT KIND?
JP Morgan's and Blackrock's proposed copper ETFs look more targeted, and each company obviously feels the target is worth two years (and counting) of jousting with the regulators.
So who would be the target investor big enough to absorb 180,000 tonnes of copper?
The "man in the street" seems a highly unlikely proposition, particularly since ETF Securities is itself a specialist in bringing wholesale investment options to the retail market.
Nor would it be any part of the investment community already active in the copper market, whether directly or via an index such as the DJ-UBS Copper Sub-Index or the legion of CTAs.
The one part of the investment universe that would have the appetite for such a product and the collective fire-power to justify the tonnage implied by the two listing documents would be the ultra-conservative U.S. pension fund sector.
Many pension funds are required by their own rules to invest only in U.S.-listed securities. Many are explicitly forbidden by the same rules from having anything to do with a derivatives market, even a well established futures market such as COMEX copper.
For such players, investing in copper really comes down to buying the shares of Freeport McMoRan. There simply aren't a lot of other options.
A U.S.-listed ETF backed by physical metal with no linkage to anything that might be deemed a "derivative" would tick all the right boxes.
But if such slumbering giants are the target of the two proposed copper funds, analysing the impact of ETF Securities' physical copper ETF on price is about as relevant as comparing copper with, well, gold.
Moreover, pension funds would probably be a different type of investor than those currently involved in the ETF space, more long-term "buy-and-hold" than short-term "chop and change".
In which case, copper fabricators are probably right to be worried.