For exchange-traded fund investors, the commodity story seems irresistible: News stories abound concerning soaring lumber prices and food inflation, while rising prices at the gas pump are a regular reminder of rebounding energy prices.
The logical move may seem to pile into commodity ETFs, but recent data suggests Canadians are still hesitant. Despite $7-billion in new investments in ETFs in May in Canada, investors withdrew holdings from commodity ETFs, mostly in precious metals, with $24-million in outflows, according to National Bank Financial Inc.
Above all, investors need to recognize that not all metals, materials and energy products behave like lumber.
“They see quintupling prices in a very short time and they interpret that to be a harbinger of things to come across the entire commodity space,” says Daniel Straus, director of ETFs and financial products research with National Bank of Canada Financial Markets in Toronto.
“I think that is a little too neat of a narrative.”
Surging lumber prices are the result of a unique set of circumstances including sawmill shutdowns and inventory liquidation at the start of the pandemic last year. It created “a giant inventory shock,” Mr. Straus says, followed by an unexpected renovation and housing boom.
While commodities are a good way to keep pace with inflation, Mr. Straus cautions that most ETFs track commodities with a lag, which makes them less suitable for long-term holdings in a portfolio.
“It is the commodity spot prices that track with inflation. ETFs that are out there, unless they are precious metals commodities, all universally use futures for their exposure. They either hold futures directly or they track futures-based indexes through a debt instrument or swaps, things like that,” he says.
The potential downside of futures-based commodity ETFs is they’re subject to roll yield, as fund managers enter and exit futures contracts to keep exposure to the tracked commodity. If futures contracts increase during the holding period, the contract holder can earn a positive return, or a negative return if the contract falls in price.
A way to avoid negative roll yield worries when getting exposure to the commodity sector is to concentrate on precious metals, Mr. Straus says. His recommended ETFs include physical gold ETFs such as the Purpose Gold Bullion fund (KILO-T), with a management expense ratio (MER) of 0.25 per cent. KILO is up 7 per cent over the past year. It also has a non-hedged version, KIL0.B, with an MER of 0.23 per cent that’s down 3 per cent over the past year and U.S.-dollar version KILO.U with an MER of 0.24 per cent that’s up 9 per cent over the past year. (All data from Morningstar as of June 4).
He also cites the relatively new unhedged CI Global Asset Management’s CI Gold Bullion Fund (VALT.B-T) with a management fee of 0.155 per cent for all three classes: The unhedged VALT.B is up 5 per cent since it launched March 22. The Canadian-dollar version, VALT, and the U.S.-dollar version, VALT.U, are each down about 2 per cent since they launched in early January 2021.
A “larger, more liquid” ETF for gold, he notes, is the iShares Gold Bullion ETF (CGL-T), with an MER 0.55 per cent for the Canadian-dollar hedged version, which is up 8 per cent over the past year. The non-hedged version, CGL.C-T, has an MER of 0.56 per cent and is down 2 per cent over the past year.
“There are so many gold products in Canada,” Mr. Straus says.
For investors looking for a broader basket of precious metal commodity ETFs, the U.S. market has options like the Aberdeen Standard Investment’s Physical Precious Metals Basket ETF (GLTR-Q), with an MER 0.60 per cent, which tracks the spot prices of gold, silver, platinum and palladium. The ETF is up 26 per cent over the past year.
Another option for investors is the Direxion Auspice Broad Commodity Strategy ETF (COM-N), which is managed by Calgary’s Auspice Capital Advisors. It holds a broad basket of 12 commodities, including precious metals, agriculture products such as grains and sugar, and energy such as crude oil and gasoline. COM has an MER of 0.70 per cent and has returned 40 per cent over the past year.
“Commodities is the most diverse sector of assets,” says Tim Pickering, president and founder of Auspice. “You can have months like [this May] where you have some commodities in a single sector like wheat is coming off and corn is coming off and canola is rallying.”
Adds Mr. Pickering: “That diversity makes it very valuable to a portfolio, makes it very valuable from an investment perspective to generate alpha. It’s (also) a very hard sector for the retail investor to gain access to.”
Mr. Pickering, who managed commodity ETFs in Canada in the past, is working on creating a broad commodity fund for Canadian investors currently to appeal to those who do not want to own a U.S.-listed fund.
“Done right, commodities are truly the right inflation protection tool,” he says. “You can see that in the last year. Commodities are a great place to be with the caveat that, if you pick one thing and kind of hope it will save the day, it may not work.”
Even though gold is often part of his U.S. commodity ETF, Mr. Pickering doesn’t consider the yellow metal as a great inflation shield for every occasion.
“The last year really highlights that, you have had inflation kick in and we had commodities take off. What did gold do? It turned around and went down.”