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Mining ETFs Crumble On Copper Collapse

Acting as a leveraged play on the underlying commodities, metal & mining stocks, and ETFs have been under pressure over the last two years on weak global commodity trends. The year 2015 might dig up the same sad story, with perhaps more pain in store. Geopolitical tensions, global growth uncertainty, oil price havoc, strong dollar, and global supply glut continue to weigh on this corner of the space. Notably, a rising U.S. currency makes dollar-denominated assets more expensive to foreign investors, thereby dulling the appeal for the commodities. Inside the Slump The most recent plunge came from a broad selloff in the industrial metal sector on Tuesday and Wednesday. Copper was hit the hardest, plunging to below the five-year low. The red metal is vital to the growth of the global economy as it is a raw material in construction and manufacturing activities. About 45% of the demand comes from China, which is struggling with slow growth and thus weak consumption. Lead dropped to a 31-month low, nickel close to a one-year low, while zinc and aluminum are trading at eight- and seven-month lows, respectively. The downward revision to the global outlook this week by the World Bank unnerved investors across the board. The bank lowered its global growth forecast to 3% from 3.4% for 2015 and to 3.3% from 3.5% for 2016. This is primarily thanks to sluggishness in Euro zone, recession in Japan, and weakness in key emerging markets like Russia, Brazil and China despite the stronger U.S. economy. Further, oil price is not showing any signs of reversing, raising fears of deflation across the globe. Adding to the woes is Citigroup’s reduced price target for iron ore to $58 and $62 for 2015 and 2016, respectively, from $65 for both years. Further, it stated, “the industrial commodities are being in the midst of a deflationary spiral, driven by lower oil prices, falling fx and efficiency gains.” The firm also expects earnings of major miners to fall 9-21% in 2015 and 3-16% in 2016. Given this, the mining stocks have seen terrible trading with most of them losing in double digits in the last two sessions. Below, we have highlighted three ETFs that slipped to multi-year lows and could see steeper falls in the days ahead if the current trends persist. SPDR S&P Metals & Mining ETF (NYSEARCA: XME ) This ETF offers broad exposure to the metal and mining industry by tracking the S&P Metals & Mining Select Industry Index. Holding 36 stocks in its basket, it uses an equal weight methodology and does not put more than 4.4% of assets in a single security. In term of industrial exposure, steel makes up for large chunk at 39%, while coal & consumable fuels, and diversified metal and mining round out the top three. The product has $347.7 million in AUM and is liquid with solid trading volumes of more than 2 million shares per day on average. It charges 35 bps in fees and expenses. The fund slid to a multi-year low of $26.89, having lost about 10.5% so far in the year. iShares MSCI Global Metals & Mining Producers ETF (NYSEARCA: PICK ) This fund follows the MSCI ACWI Select Metals & Mining Producers Ex Gold & Silver Investable Market Index, which provides global exposure to companies that are involved in the extraction and production of diversified metals, aluminum, steel, and precious metals and minerals. It has amassed $159.5 million in its asset base while trades in light volume of under 50,000 shares. Expense ratio came in at 0.39%. The ETF holds a broad basket of 209 securities with the largest allocation to BHP Billiton (NYSE: BHP ) and Rio Tinto Plc (NYSE: RIO ) with 10.9% and 8.4% share, respectively. About three-fifths of the portfolio is dominated by metals & mining, closely followed by steel (32%). Australia, U.S. and United Kingdom are the top three countries with double-digit allocation. PICK has dropped 8.7% so far this year to an all-time low of $14.22. Global X Copper Miners ETF (NYSEARCA: COPX ) This ETF targets the copper mining industry across the globe. It follows the Solactive Global Copper Miners Index and holds 25 stocks in its basket with none holding more than 6.25% share. In terms of a national breakdown, Canada takes the top spot with 36% of assets while Australia, Mexico and United Kingdom round out the next three spots with double-digit exposure. The product has managed $19.9 million in AUM while charges 65 bps in fees per year. It trades in light volume of 37,000 shares a day on average. The fund lost about 16% in the first few days of 2015 and hit an all-time low of $6.07.

Market Timing Vs. Macro Decision Making

Here’s a very good post over at Brooklyn Investor on some of the differences between market timing and macro hedge funds. As more and more people become index fund investors I think these concepts become increasingly important to understand because all index fund investing is a form of macro investing (picking aggregates). But being an “asset picker” doesn’t make you a “market timer” in the sense that I think many people have come to think. First, market timers are people with extremely short time horizons. These are the people who think they can time the daily, weekly or monthly moves of the market. For some perspective, you can see how much the average holding period has declined over the years: If you go back even further in history the holding period used to be quite a bit longer (as high as 7 years). The crucial point in the discussion about how “active” an investor is really comes down to efficiency in decision making as opposed to “passive” vs “active” (since we’re all “active” to some degree). That is, we all deviate from global cap weighting, we all rebalance, lump sum invest, alter our risk profile, “factor tilt”, etc. Portfolio construction and maintenance is an active endeavor by necessity. The more important questions revolve around how we are optimizing frictions around our decisions. This comes down to two big points: Taxes will take between 15-38% of your profits. Reducing this friction is crucial. A tax aware investor not only uses the proper products to maximize after tax returns, but implements a portfolio that takes advantage of long-term vs short-term capital gains. Fees are the other big friction in a portfolio. As I’ve described before , the difference between using a 1% fee fund and a 0.1% fee fund over the long-term will result in tremendous outperformance: (The fee impact of $100,000 compounded at 7% with avg MF and low fee index) The smart macro investor knows that taxes and fees are a killer in the long-term. If the global financial portfolio generates a return of 7% per year then you can’t afford to be giving away 1% in fees every year and another 1-2%+ to the tax man every year. So here’s a safe rule of thumb – the difference between a “market timer” and someone who makes necessarily “macro decisions” (even if that’s just rebalancing, dollar cost averaging or making new contributions, etc) is 12 months and one day. Since taxes are such a large chunk of our real, real return then it makes sense to take a bit of a longer perspective. Rebalancing on a monthly or quarterly basis doesn’t add much value to your portfolio and increases fees & frictions significantly. At the same time, you have to be careful about the Modern Portfolio Theory concept of “the long-term.” As I described here , taking a “long-term” perspective could actually result in taking much more risk than is appropriate for you. Our financial lives are actually a series of short-terms within one longer time period so it’s best to treat your portfolio as a “savings portfolio” instead of a higher risk “investment portfolio”. As I’ve described in detail , we’re all active investors to some degree. We are all active asset pickers in a world where we all pick asset allocations that deviate from global cap weighting. That’s totally fine! So, the discussion really comes down to how efficient we are at picking our allocations and how we implement the process by which we manage that allocation. If you’re using a very short-term strategy that results in a holding period that is less than 12 months then I’d call you a market timer who is likely increasing your frictions and hurting your overall performance. If, however, you are making macro portfolio decisions in a more cyclical nature (over a year or several years on average) then you are a macro investor who is minimizing the negative impact of portfolio frictions. Of course, the discussion about how to efficiently or effectively we “pick assets” is a whole different discussion and opens up a whole new can of worms in the “active” vs “passive” debate….

If You Think You Are Buying Into Oil, Think Again!

Summary Difficulty in finding a spot oil exposure in the market. USO ETF does not mirror oil price movements perfectly. Long dated oil futures might provide better exposure. There is a lot of hype now looking at oil given the large volatile swings in oil price and its overall drastic decline since about a year ago. For savvy investors, this article would probably not be very relevant because you might already know this. Retail investors who read about oil prices in the news and are very new to this should however, take a closer look. The average investor would probably think of going long or short oil via exchange traded funds, namely the United States Oil Fund or USO. Some information on USO ( website ) As of Jan. 13, 2015 Market Capitalization : 1,688 million Assets Under Management: 1,667 million Management Fee: 0.45% Total Expense Ratio: 0.76% (from 9.30.2014 fund update ) According to the USO website, USO is “designed to track the daily price movements of the West Texas Intermediate (“WTI”) light, sweet crude oil”. For retail investors, this is generally a liquid counter with an average of 16.7 million shares traded daily in the past 3 months. Notably, trading volumes seems to have picked up recently perhaps because of the coverage of oil prices in the news lately. As of Jan 13, the daily volume was 33 million shares traded. Caution is Advised If an investor wants to get exposure to Spot Oil prices without renting a vessel to physically store oil, the investor may have a wrong impression that a good way would be to buy or sell the USO ETF units. Here’s why this is quite ill advised. (click to enlarge) Plotting a chart of the USO ETF with the continuous CLc1 NYMEX prices shows a very obvious trend. In 2009, WTI prices rose from $40 to $80 in a year’s time. During the same period, USO ran up from $29 to $39. A very striking difference in the return profile for an investor who wishes to invest in spot oil prices but ends up buying something different. As prices collapsed in the middle of 2014, from about $100 to right now hitting $45, the USO declined from $37 to about $18. This is also slightly less than the CLc1 movement. For those interested in some numbers, I have extracted out the month-end closing prices of both the USO and the CLc1 in the table below. Month USO CLC1 (spot) USO +/- % CLC1 +/- % Jan-09 29.22 41.75 Feb-09 27.03 44.12 -7.49% 5.68% Mar-09 29.05 48.85 7.47% 10.72% Apr-09 28.63 50.88 -1.45% 4.16% May-09 36.41 66.95 27.17% 31.58% Jun-09 37.93 70.6 4.17% 5.45% Jul-09 36.81 69.5 -2.95% -1.56% Aug-09 36.05 69.57 -2.06% 0.10% Sep-09 36.19 70.4 0.39% 1.19% Oct-09 39.31 76.99 8.62% 9.36% Nov-09 39.16 76.42 -0.38% -0.74% Dec-09 39.28 79.62 0.31% 4.19% Jan-10 35.64 72.64 -9.27% -8.77% Feb-10 38.82 79.61 8.92% 9.60% Mar-10 40.3 83.38 3.81% 4.74% Apr-10 41.33 86.22 2.56% 3.41% May-10 34.05 74.09 -17.61% -14.07% Jun-10 33.96 75.37 -0.26% 1.73% Jul-10 35.34 78.99 4.06% 4.80% Aug-10 31.91 71.68 -9.71% -9.25% Sep-10 34.84 79.81 9.18% 11.34% Oct-10 35.14 81.92 0.86% 2.64% Nov-10 36.04 83.59 2.56% 2.04% Dec-10 39 91.4 8.21% 9.34% Jan-11 38.61 92.22 -1.00% 0.90% Feb-11 39.19 96.87 1.50% 5.04% Mar-11 42.58 106.79 8.65% 10.24% Apr-11 45.15 113.42 6.04% 6.21% May-11 40.5 102.59 -10.30% -9.55% Jun-11 37.26 95.12 -8.00% -7.28% Jul-11 37.43 95.86 0.46% 0.78% Aug-11 34.51 88.72 -7.80% -7.45% Sep-11 30.5 78.75 -11.62% -11.24% Oct-11 35.74 92.58 17.18% 17.56% Nov-11 38.78 100.5 8.51% 8.55% Dec-11 38.11 99.06 -1.73% -1.43% Jan-12 37.82 98.28 -0.76% -0.79% Feb-12 40.92 106.91 8.20% 8.78% Mar-12 39.23 102.93 -4.13% -3.72% Apr-12 39.68 104.89 1.15% 1.90% May-12 32.61 86.5 -17.82% -17.53% Jun-12 31.82 84.84 -2.42% -1.92% Jul-12 32.68 87.96 2.70% 3.68% Aug-12 35.89 96.56 9.82% 9.78% Sep-12 34.13 92.1 -4.90% -4.62% Oct-12 31.78 86.01 -6.89% -6.61% Nov-12 32.56 88.94 2.45% 3.41% Dec-12 33.36 91.79 2.46% 3.20% Jan-13 35.28 97.41 5.76% 6.12% Feb-13 33.06 91.83 -6.29% -5.73% Mar-13 34.76 97.28 5.14% 5.93% Apr-13 33.16 93.32 -4.60% -4.07% May-13 32.61 91.61 -1.66% -1.83% Jun-13 34.15 96.49 4.72% 5.33% Jul-13 37.36 105.32 9.40% 9.15% Aug-13 38.48 107.76 3.00% 2.32% Sep-13 36.85 102.29 -4.24% -5.08% Oct-13 34.69 96.24 -5.86% -5.91% Nov-13 33.46 92.78 -3.55% -3.60% Dec-13 35.32 98.7 5.56% 6.38% Jan-14 34.8 97.46 -1.47% -1.26% Feb-14 36.74 102.76 5.57% 5.44% Mar-14 36.59 101.56 -0.41% -1.17% Apr-14 36.32 99.68 -0.74% -1.85% May-14 37.68 102.93 3.74% 3.26% Jun-14 38.88 105.51 3.18% 2.51% Jul-14 36.31 97.65 -6.61% -7.45% Aug-14 35.76 95.84 -1.51% -1.85% Sep-14 34.43 91.32 -3.72% -4.72% Oct-14 30.63 80.7 -11.04% -11.63% Nov-14 25.58 65.99 -16.49% -18.23% Dec-14 20.36 53.71 -20.41% -18.61% Slight percentage variations in price movements can mean quite a lot to investors. Hence, it is better to understand why this occurs before making a decision to invest. Oil futures are currently in a contango, which basically means oil prices in the future, are worth more than the current price. This usually reflects some cost of handling and storage and cost of carry. (click to enlarge) Looking at the difference between a Dec 2015 futures price of $53.32 versus the front month futures price of $45.99, it may be easy for anyone to simplistically try to mirror a hedge strategy by trying to buy the USO and selling the Dec 2015 futures. The problem lies with how the USO is priced. Here is a snapshot of what the USO holds in its Net Asset Value disclosed: (click to enlarge) (click to enlarge) As shown above, as time progresses, the fund rolls over its holdings from the current front month futures (e.g. Feb 15 futures) into the next month (Mar 15 futures). In the process of rolling over its holdings, it sells the Feb 15 futures and buys the Mar 15 futures, hence incurring the differential cost or spread between the Feb and Mar products. In the USO prospectus page 18, this phenomenon is explained and illustrated in the example quoted below. “If the futures market is in contango, the investor would be buying a next month contract for a higher price than the current near month contract. Using again the $50 per barrel price above to represent the front month price, the price of the next month contract could be $51 per barrel, that is, 2% more expensive than the front month contract. Hypothetically, and assuming no other changes to either prevailing crude oil prices or the price relationship between the spot price, the near month contract and the next month contract (and ignoring the impact of commission costs and the income earned on cash and/or cash equivalents), the value of the next month contract would fall as it approaches expiration and becomes the new near month contract with a price of $50. In this example, it would mean that the value of an investment in the second month would tend to rise slower than the spot price of crude oil, or fall faster. As a result, it would be possible in this hypothetical example for the spot price of crude oil to have risen 10% after some period of time, while the value of the investment in the second month futures contract will have risen only 8%, assuming contango is large enough or enough time has elapsed. Similarly, the spot price of crude oil could have fallen 10% while the value of an investment in the second month futures contract could have fallen 12%. Over time, if contango remained constant, the difference would continue to increase.” Conclusion I hope I have driven the point across on the USO ETF, that it is a means to get exposure to oil price movements, but it is nowhere near a perfectly correlated product.