Seeing Red
Just over two months since confirming its plans to launch exchange-traded products (ETPs) physically-backed by industrial metals, ETF Securities has brought its ETFS Physical Copper (PHCU), Physical Nickel (PHNI), and Physical Tin (PHSN) securities to the London Stock Exchange. These products take the form of transferable securities which are ultimately backed by their relevant physical metals. Ownership of the metals is established through London Metal Exchange (LME) warrants or warehouse receipts, which serve as a claim on physical metal (which conforms to LME standards) stored in LME-approved warehouses.
Fundamentally Sound
Much of the excitement around the launch of the world's first physically-backed copper ETP can be attributed to the fact that the fundamentals of the copper market are presently very favourable for suppliers of the red metal. In its most recent market forecast, issued in October, the International Copper Study Group projected a 435,000 tonne deficit in refined copper supply in 2011. This industry-watching NGO anticipates that global demand for refined copper will rise 4.5% in 2011, driven in large part by an anticipated 6% increase in Chinese industrial usage. Meanwhile, refined supplies are expected to rise by a mere 1%.
Expectations are consequently running high for the copper price, which recently touched a new all-time high. Many banks have put copper at the top of their trade pick lists for 2011. In its recently issued global outlook for 2011, Barclays Capital stated, "Copper and tin are set to hit further all-time highs next year, making them our picks from the base metals complex."
While the near-term investment thesis for copper seems to be fairly solid, is a physically-backed product necessarily the vehicle of choice for obtaining copper exposure?
Lofty Carrying Costs
Precious metals like gold and silver have a much higher value-to-weight ratio than industrial metals and as such are far less costly to store. At the moment, a troy ounce of gold is worth approximately $1,380, while an equivalent amount of copper is worth about $0.23. For instance, the Source Physical Gold ETC (SGLD), db Physical Gold ETC (XGLD), and RBS Physical Gold ETC, each levy a total expense ratio (TER) of 0.29%--the lowest amongst all physically-backed gold ETPs in Europe. Meanwhile, ETFS Physical Copper has a management expense ratio (MER) of 0.69%, charges an insurance allowance of 0.12% per annum, and is liable for rental fees of 36 cents per tonne per day (which amounts to about 1.43% annually at recent copper prices). So on an all-in basis, investors in ETFS Physical Copper are likely to see 2.25% of their investment paid away in carrying costs over the course of a year.
What is the Alternative?
One of the appeals of owning a security backed by a physical commodity is that it eliminates the need to be concerned with the sources of return unique to using commodity futures to obtain commodity exposure. More specifically, it does away with the need to regularly roll futures contracts in order to maintain constant exposure and the potential gains and losses associated with this process (for more on this topic please see our article Be Cautious with Commodities). While passive investors in long futures strategies in natural gas and oil markets have recently seen strong spot price returns dominated by negative roll returns--attributable to contango--should investors looking for copper exposure be similarly concerned? The short answer is, no--not at the moment anyway.
For example, ETFS Copper (COPA) tracks the DJ-UBS Copper Sub-Index. This index measures the performance of a passive long-only investment in copper futures that rolls into new futures contracts five times per calendar year. The index is currently fully invested in copper futures contracts that are scheduled to expire in March of 2011. Come March of next year, the index will roll out of its March contracts and into May 2011 contracts over the course of five trading days. At the time of this writing, March 2011 copper futures contracts are changing hands for $4.1090 on the Chicago Mercantile Exchange, while May contracts are going for $4.1075. Selling a March 2011 contract for $4.1090 and subsequently purchasing a May contract for $4.1075 would create a hypothetical roll gain of 0.03%.
This is a simplified example and we are operating within a static model, but given that the copper futures curve is essentially flat at the moment and investors in ETFS Copper are subject to a TER of 0.49%, it would appear to be a superior option to a physically-backed product subject to all-in carrying costs in the neighbourhood of 2.25%. What's more, given the outlook for further tightening in copper supply-and-demand fundamentals, the copper futures curve could very likely become backwardated (nearby futures trading at a premium to distant futures, leading to the potential for even more positive roll returns) as copper buyers become increasingly competitive over shrinking supplies.
So while there has been much fanfare surrounding the launch of ETF Securities' physically-backed copper ETP, the latest vehicle to offer investors exposure to the red metal is by no means the greatest.
