Playing the Commodities Boom With Base Metal ETFs

by Taras Berezowsky on

Part One: Investment Plays on the Commodities Boom

Figuring out the best investment plays on the recent commodity boom we’ve been seeing isn’t an open and shut case. There are many different factors to consider; apart from the “what (what metals should I be investing in?), the “why (are metals a safe bet with all the volatility surrounding them?) is just as important. Think of the “tail risks, as some analysts call them, that the world has on its plate right now: first the massive European credit downgrades of the national economies of Greece/Portugal/Ireland etc., then the domino effect of Middle Eastern revolt, then the horrific quake and tsunami in Japan. This triple whammy definitely opens the door to an unforeseen “fog of uncertainty, said ETF Securities senior analyst Daniel Wills in a conference call last Thursday.

Due to volatility inherent in supply disruptions and political unrest, what could mean high prices and higher yields for some could mean headaches for others. Over the past 10 years, commodities as an asset class have consistently yielded more positive returns than real estate, equities or cash. If industrial supply tightens, base metal prices will continue rising. But how much do physically backed metal ETFs have to do with supply constriction?

In following the base metal ETF front for a few months, it appears to us as though the inflows/outflows of physical metal are not overwhelmingly factoring into the global demand and supply equation. Consider the graph below, courtesy of ETF Securities:

Source: ETF Securities

Although industrial metals ETPs have seen increasing dollar inflows over the past four months, the proportion of metals ETPs to the rest (for example, oil and food) is rather marginal. (The graph takes gold ETPs out of consideration, which account for a vast majority of ETF dollar inflows.) From this, can we infer that physical base metals don’t play a meaty part in the supply landscape?

Not necessarily. Although base metal ETF warehouses might be stocking a relatively small chunk of the physical metals on the market, the trend of rising inflows may speak volumes of what speculators, investors and buyers are doing getting their hands on ever scarcer materials sooner rather than later. This is especially true for emerging markets, which are eating up copper, aluminum, nickel and iron ore faster than ever. Add in half a nation (Japan) that must rebuild after incurring $235 billion in economic losses, and the appetite for base metals at least in the short- to medium-term has grown considerably.

Part 2: Speaking of Tail Risks¦

Instead of using gold as a safe-haven asset in the traditional investment context, Libya’s leaders may need it to continue financing their internationally condemned attacks against their own citizens. The concern is leader Moammar Gadhafi may be using his country’s stash of gold to leverage his war costs by getting it outside Libya’s borders (made illegal in Egypt post-revolution so that leaders couldn’t smuggle their wealth out) in exchange for weapons, food or cash, according to the Financial Times.

The International Monetary Fund estimates that Libya’s Central Bank which is under Gadhafi’s control holds 143.8 tons of gold. That translates to roughly $6.5 billion in market value, meaning big bucks that can be used to pay soldiers for a long time.

Gadhafi may have trouble getting anyone to buy or swap for his “conflict gold, but, interestingly enough, the unrest spurred by his military actions continues inflating the price of the yellow metal and hence, the value of his Ëœpersonal stash’ every single day. Should he be able to cash out, the sly fox might be laughing all the way to the bank.

–Taras Berezowsky

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