Needless to say, commodity funds of all kinds have been doing well recently. The weekly chart of DBC shows the general commodity market over the past two years, represented by crude and heating oil, gold and aluminum, wheat and corn. Until August 2007 there was a flat consolidation range after the rises into 2005/2006. Then with the central bank lowering of interest rates, and with strong suggestions from them of further reductions, both the hopes of avoiding deep recession, and the fears (or bets on) further inflation. led to upside breakouts in many broadly-based liquid commodity markets.
This year I have posted two articles on some of the commodity funds available to ETF and ETN stock and to mutual fund investors: January 27, 2008 and February 10, 2008. In the more recent article I showed a chart which was forwarded to me and whose origins I do not know. It lays out the sector weightings of the major US commodity Indexes which are often used as benchmarks and actual allocations by ETF. These indexes are key to choosing one's own preferred commodity exposure. Commodity Index Allocations
I've explained my own biases, or preferences before: in tax-deferred accounts (IRA's and 401k's in the US) there is little to be gained by putting funds in which generate no income. With tax-deferred accounts everything coming out eventually will be taxed at ordinary income tax rates of up to 35% and tax rates are virtually certain to rise in 2009/2010. With commodities we are primarily looking for capital appreciation, not income. So commodity funds which give you only capital appreciation should be in taxable accounts, in my personal opinion.
For commodity exposure inside tax-deferred accounts I am using two mutual funds I have discussed in the January and February posts above: HSTRX (Hussman Strategic Total Return) and PCRIX (Pimco Commodity Real Return). Both use US TIPs as their income-yielding base. HSTRX gets an exposure to gold (and some minor exposure to other metals) through trading gold stocks around a basic allocation of approximately 15%. PCRIX (or PCRDX with lower minimums) overlays its TIPs with a commodity-linked note tied to the Dow Jone-AIG Index, a broad-based index based on US commodities and three London metals (see the allocation gif). Both of these funds paid dividends over 5% last year and the TIPs of course are adjusted for US CPI inflation. Since TIPs taxation can be an extra issue in taxable funds, I prefer to avoid it by carrying funds with TIPs in tax deferred accounts. So for PCRIX and HSTRX (I own both) I like them for my tax-deferred funds and they give commodity/gold exposure with an income kicker.
For taxable accounts I prefer the commodity exposure with potentially the lowest capital gains exposure and little if any income exposure. In my view the worst funds for this scenario are the gold and silver ETFs which actually hold bullion: GLD, SLV, and CEF (Canadian) and other physical holders of commodities (gold). First of all they do not permit you to convert your shares to gold (or other holdings) unless you convert very large amounts (see individual prospecti for limits and fees), so in owning them you do not really own the gold, only share certificates for that gold which you can sell or buy. So these ETF's are in effect "derivatives" in a generic sense. However, the IRS regards their holdings as "collectibles" whose gains are taxed at a flat rate of 28% even if you were in a 10-25% normal Federal income tax bracket. So I can see no advantages to owning them either inside or outside a tax-deferred account.
CEF has another disadvantage in that it can and may be deemed by the US IRS to be a "passive foreign trust". That designation requires you to file a "special election" form with the US IRS, with your first annual return after purchase of CEF (and its all gold sibling GTU), on which of two possible tax statuses you wish to adopt with regard to passive foreign trusts. Then too, CEF holds physical gold and silver which you cannot get in redemption, as with SLD, SYL and others, and you will be subject to Canadian taxes as well. If you own enough of it to make having an accountant and possibly a tax lawyer's time be worth while on these issues, these funds may be feasible holdings. But I'll skip them. If I want physical gold, I buy physical gold.
Since those funds are in fact derivatives and not your own segregated gold or silver, why not use real exchange-traded regulated derivatives in an unleveraged manner? I'm talking about unleveraged US futures contracts which are taxed at a much more favorable US tax rate. With futures, all capital gains, no matter whether a day trader or of a long term investor are taxed such that 60% of any gains are considered long term and 40% short term. With current long term rates of 10-15% and maximum short rates of 33-35%, you come out far ahead with futures-based derivatives rather than with collectible ETF derivatives. As an example, on $200,000 taxable joint filing income, collectibles gains would be taxed at a flat 28% rate while futures gains would be taxed at 18.04% , a sizable difference! Keep in mind, as always, that I am not a tax adviser, and this discussion is just my amateur tax payer opinion. Do the math yourself, or ask your own tax accountant and/or tax attorney. Also I am not a licensed investment adviser, just an amateur investor of my own family's accounts, so none of this should be considered as advice, merely my own analysis for my own sake.
There are several ETF's which do invest in commodity futures in an unleveraged manner. They deposit their dollar assets as US T Bills (or similar money market instruments) and buy commodity futures contracts whose values are not to exceed the face value of the contract. ZERO leverage. I have looked at the iShares DB funds:
DBC (gold, aluminum, crude and heating oil, corn and wheat); DBE (light sweet WTI and Brent crude oil, RBOB gasoline, and natural gas); DBO (light sweet WTI crude oil only); DBP (gold 80%/silver 20%); DGL (gold); DBS (silver); DBB (aluminum, zinc, copper); and DBA (corn, wheat, soybeans and sugar). These may fit a niche need for some portfolios or work as good trading vehicles. I do not own any of these funds but DBC does track the large commodity universe quite well. DB's futures traders have a long and admired history, so managing indexed and re-balanced portfolios is like falling out of bed for them. The volumes of their trading should/could result in lower than average commissions and other transaction costs.
My favorite to date in the tax-favored, futures-based a category is Greenhaven Continuous Commodity Index Fund (GCC). The CCI is a previous incarnation of the famous CRB Index and has 17 US-traded commodity futures in it with equal weighting for each. So crude oil and cocoa are equally weighted. In a long term commodity bull market, which I believe we are in, every commodity will have its day in the sun, and I want to be there and own them all. Volatility should also be lower in a fund with 17 equally-weighted holdings than with two to six commodities. So I will feel safer carrying a larger position in this rather than an energy or metals heavy fund. This fund is new and is the only listed fund of its management. But they have led public commodity pools for a long time.
As a former commodity futures trader for decades I feel cvery omfortable with the commodity futures, with the US futures exchanges, with their clearing houses, and with CFTC and SEC regulation. US futures have been around for 150 years and have a splendid record of safety and regulatory excellence. And with zero leverage I feel these are safe for me with modest amounts in order to hedge against inflation and achieve additional diversification in a complete portfolio. I own this fund, and made my first purchase on their third day of existence. As always let me assure you that I have no other connection with these people or any of the others of any funds. I am totally and only a private investor with no personal or family ties to the investment industry. These are simply my own opinions which may be of interest.
There are a number of other commodity funds not covered here as I haven't looked at them as deeply, so leaving them out does not necessarily imply I find them wanting, and I might include some of them in future .
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