SIVR: new silver ETF…Silver Safer Than Gold, Natural Gas: Commodity Exec

The silver market is outpacing gold this year, and for those looking to buy into the metal, there’s now a new method.

ETF Securities, the largest provider of commodity-based exchange-traded funds (ETFs) in Europe, recently created a new ETF for silver.

“It’s the first step in building a platform for commodities,” said Graham Tuckwell, founder and chairman of ETF Securities.

Those buying into the ETF, which operates under the ticker SIVR [SIVR 13.31 -0.44 (-3.2%)], aren’t buying into futures. Rather, they are purchasing an actual piece of metal that is stored in a vault and stamped with a serial number.

Natural Gas ETF Plunges More Than Fuel Even as Shares Sell Out

The largest exchange-traded fund for natural gas, so popular that it ran out of shares two weeks ago, it has lost 43 percent this year and probably will keep falling until winter, trailing the fuel it’s supposed to track.

The United States Natural Gas Fund will suffer from record- high gas inventories and seasonal prices hitting the ETF harder than the fuel, said Teri Viswanath, the director of commodities research at Credit Suisse Securities USA in Houston. Investors piled into the fund this year, driving up its number of outstanding shares 11-fold.

“The amount of interest in this fund is a surprise given the trend in gas is down and not looking to change any time soon,” said Tom Orr, the director of research for Weeden & Co. LP, a Greenwich, Connecticut, securities brokerage, in a telephone interview. He predicted natural gas, this year’s worst performing major commodity, will fall below $3 per million British thermal units next month, from $3.669 on July 17, and rise to $4 in the fourth quarter.

The $4.6 billion fund, managed by United States Commodity Fund LLC in Alameda, California, made 300 million new shares available May 6 and grew to 347.4 million shares before running out July 7. It’s awaiting Securities and Exchange Commission approval to sell up to a billion more.

“If I knew then what I know now, we certainly would have registered a lot more shares than 300 million back a few months ago,” said John Hyland, the ETF’s chief investment officer.

Commodity ETF Boom

Its popularity coincides with a boom in commodity-backed funds. Investors poured $16.9 billion into such ETFs this year through May 31, more than triple last year’s first five months, according to the Investment Company Institute, a Washington trade group.

The Commodity Futures Trading Commission, in an effort to prevent speculators from pushing around energy prices, will hold hearings this month on limiting how many oil and gas futures that speculators, including ETFs, can hold. The Industrial Energy Consumers of America wants the SEC to block the fund’s expansion to prevent “excessive speculation,” according to a July 16 letter from the trade group, which includes Goodyear Tire & Rubber Co. in Akron, Ohio, and Tyson Foods Inc. in Springdale, Arkansas.

Investors bought the natural gas fund expecting the fuel to rise after it fell in June to the cheapest level compared with oil since 1992, Orr said. Instead, gas continued a yearlong slide. Since Dec. 31, natural gas futures on the New York Mercantile Exchange have declined 35 percent, 8 percentage points less than the ETF’s drop.

High Supplies

Fuel stockpiles increased 90 billion cubic feet the week ended July 10, reaching 2.886 trillion cubic feet, the highest for any July since the Energy Department started keeping records 15 years ago. Consumption by factories, steel mills and chemical plants, which accounts for 29 percent of U.S. demand, tumbled 13 percent in 2009’s first four months compared with 2008, the most recent Energy Department data show.

Viswanath predicts supplies will reach an all-time high by late October, making price increases unlikely until the first quarter of 2010, when cold weather and the early stages of an economic recovery boost demand.

The fund aims to mimic price changes in futures contracts on natural gas delivered to Henry Hub in Erath, Louisiana. It buys contracts for delivery in the next, or front, month. As those contracts near expiration, the fund sells and replaces them with the following month’s futures, a process called rolling.

Contango

Rolling hurts performance when the current contract is worth less than the next month, known as contango. The natural gas market has been in contango 94 percent of the time since the fund started in April 2007, compared with 78 percent since April 1990.

Contango doesn’t matter as much when prices rise. Gas cost $7.50 when the fund debuted and increased 81 percent to a 2 1/2- year peak of $13.58 on July 3, 2008. The fund gained 25 percent during that time, besting the Standard & Poor’s 500 Index, which fell 14 percent.

The ETF gave retail investors a way to “tag along on the commodity plays,” said Orr, who sometimes trades the fund in his personal account. When the fund started, “contango was not a factor, since people saw gas in a bull trend.”

From last year’s peak to now, gas has fallen 73 percent, and the S&P 500 has lost 26 percent. The gas ETF is down 79 percent.

‘Double Whammy’

For the fund’s investors, “even if prices stay stagnant, they lose on the roll,” Viswanath said. “If prices fall, it’s a double whammy.”

The steeper the contango, the more expensive rolling becomes. Contango has started increasing in late August and remained elevated for up to about three months every year for the past decade, data compiled by Bloomberg show. On Aug. 28, 2008, the spread between the front and second months doubled to 42 cents. On Aug. 30, 2007, it surged six-fold to 97 cents.

August is when traders move out of bearish bets made during the U.S. summer to wager that Gulf of Mexico hurricanes or cold snaps will increase prices as winter approaches, said Chris Jarvis, president of Caprock Risk Management LLC in Hampton Falls, New Hampshire.

Hyland, the fund’s chief investment officer, said contango is just one issue to consider when investing. The ETF offers a way to diversify, to bet on energy and to hedge against inflation, he said.

Profiting ‘Easily’

“The fund was designed for the majority of investors, both professional and retail, who can’t or don’t want to invest directly in futures,” Hyland said in a July 14 telephone interview. “If you believe that natural gas is cheap and that it’s going to rally and move back to the $7 or $8 range, then even if it stayed in contango the whole time, you could easily come up with a scenario where you make money.”

Jarvis said investors can profit on the ETF and avoid contango’s bite with options to buy shares in January and February at prices set now. Buyers would profit if the fund gains more than the sum of that so-called strike price and the option’s cost.

He predicted gas prices as high as $5.20 by then because producers will struggle to meet increased demand as the economy recovers. The number of active U.S. rigs has fallen to a seven- year low of 665 from a peak of 1,606 on Sept. 12, according to Baker Hughes Inc., an energy services company.

“The value on the curve isn’t in the front month,” Jarvis said. “It’s in the January and February contracts.”

Traders swing for the fences with leveraged ETFs

Double or Triple leveraged ETFs

Boston (MarketWatch) — Everyone knows that in baseball, a triple is better than a single. But highly traded ETFs designed to magnify the market’s daily moves by as much as three times probably shouldn’t be fielded in most individual investors’ portfolios, experts say.

Some investors might be surprised to know that 300% leveraged exchange-traded funds tracking the financial sector managed by a little-known Boston-based firm are routinely among the most highly-traded securities in the U.S.

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Direxion Daily Financial Bull 3x Shares (FAS 8.36, +0.02, +0.24%) seeks daily investment results, before fees and expenses, of three times the price performance of a financial-stocks index. Meanwhile, Direxion Daily Financial Bear 3x Shares (FAZ 5.12, -0.01, -0.19%) is programmed to deliver 300% of the inverse, or opposite, of the sector’s daily gyrations. This bearish ETF can be used to bet against the banking sector, or hedge.

When action heats up in the financial sector, traders flock to these ETFs to double-up or triple-up on their wagers. The juiced-up financial Direxion ETFs are often among the U.S. trading-volume leaders, sometimes reaching 500 million shares changing hands in a single day. They can see wild swings with gains and losses topping 40% in one session, while the average holding period for these funds is less than a day.

“These ETFs are designed for fast bets,” says Ken Leon, an analyst at Standard & Poor’s. “Get in and get out.”

Power hitters
When the U.S. ETF business was getting off the ground in the 1990s, most of the products were simply index funds packaged in a low-cost, tax-efficient wrapper that could be traded on an exchange. Traders and hedge funds were attracted to the ability to trade market segments and industry sectors during the day. But many of the features of ETFs also made them suitable holdings for investors and financial advisers with a buy-and-hold approach.

However, the leveraged and inverse ETFs should not be grouped into the same category as their plain-vanilla forerunners.

“They are very different from equity-based ETFs,” Leon said. “There are lots of caveats with leveraged and inverse ETFs.”

Aside from their bone-jarring volatility, over the long term the targeted leverage doesn’t hold up, due to the effects of compounding returns and the way in which the ETFs reset the leverage on a daily basis. In other words, just because the tracking index has risen 5% for a given month, it doesn’t mean the twice-leveraged bullish ETF will post a 10% return. In volatile markets, the results can become even more skewed, so investors need to keep a very close eye on these ETFs.

That said, the brisk trading volume and extremely brief holding periods of leveraged ETFs suggests the products are being used as they were designed — as short-term trading vehicles.

Just counting the U.S. ETF market, leveraged and leveraged-inverse portfolios command only about 5% of overall market share by assets, according to industry research.

There are a wide range of users, including hedge funds, day traders and investors putting hedging strategies to work. The inverse ETFs allow investors to “short” markets, or profit from declines, without opening up a margin account. There are leveraged and inverse ETFs, as well as exchange-traded notes, covering various markets such as stocks, commodities, currencies and Treasury bonds.

The leverage allows investors to take market positions with less capital. With bearish ETFs, investors can lose a lot fast, but their losses aren’t unlimited as when shorting individual stocks.

“They’re very interesting products, and they’ve really caught on in markets,” said Leon at S&P. “Although most are fairly new with limited track records.”

He stressed other key features of leveraged and inverse funds that investors need to understand if they trade what some call ETFs on steroids.

Most index-tracking ETFs invest directly in stocks or bonds. But with leveraged and inverse funds, the underlying portfolio is often comprised of derivatives and futures contracts. As a result, the ETFs aren’t as tax efficient as traditional ETFs, and investors are taking on counterparty risk if the fund utilizes swaps. The credit risk of bearish financial ETFs became an issue when the short-selling of certain financial stocks was temporarily banned during the credit crunch.

Doubles and triples

In ETNs, Invesco PowerShares and Deutsche Bank have partnered to offer leveraged commodity products such as PowerShares DB Crude Oil Double Long ETN (DXO 4.13, 0.00, 0.00%) . See related story on ETNs.

There are leveraged and inverse ETFs for commodities, currencies and stocks. This market is dominated by ProShares, Direxion and Rydex Investments.

ProShares was first on the scene with bull and bear versions tracking market indexes, offering 200% daily leverage. Direxion, which was known as Potomac Funds until 2006, upped the ante with three-times leverage, or 300%.

The aforementioned Direxion financial-sector ETFs have seen phenomenal trading volume, even though the funds are less than a year old. The ETFs have at times performed like Mexican jumping beans as the uncertainty hovering over banks has attracted legions of traders betting for or against financial stocks.

Andy O’Rourke, Direxion’s marketing director, in an interview said the firm was “a bit surprised” by the trading in the financial-sector funds that go by the tickers FAZ and FAS. At the end of May, the pair had about $3 billion in assets combined.

“We didn’t expect them to be quite so hot,” he said, arguing the funds fill a particular niche.

“The herds move from one sector to another,” O’Rourke added.

As a firm, Direxion has seen its assets under management jump to $6.6 billion at the end of May, from $1.5 billion at the end of November 2008. ETFs account for $4.8 billion of the current total.

“Most of our assets have come from ETFs,” O’Rourke said. “They’re trading products, for sure. We want investors to understand what they’re buying.”

Direxion Daily Financial Bear 3x Shares touched an intraday high of $201.86 in November 2008, according to FactSet Research. On June 9, it closed at $4.34 a share, a loss of nearly 98%.

Despite having just $1.6 billion in assets at the end of May, $43 billion worth of Direxion Daily Financial Bear 3x Shares shares traded hands in May, says IndexUniverse.com editor Matt Hougan.

“That’s $2.2 billion a day, meaning the fund turned over its entire portfolio every single trading day of the month,” he said, sourcing data from the National Stock Exchange. Direxion Daily Financial Bear 3x Shares was down nearly 88% for the year-to-date period through June 9, according to Morningstar Inc.

ProShares UltraShort Financials (SKF 44.72, 0.00, 0.00%) , a 200% leveraged bearish ETF, has more than $1 billion in assets. ProShares and Rydex have reportedly filed to launch their own ETFs that give 300% leverage.

ProShares Chairman Michael Sapir said through May, the firm has seen nearly $8 billion of inflows so far this year. Total assets are roughly $26 billion.

Leveraged and inverse ETFs opened up sophisticated strategies to an untapped user group, he said. ProShares toiled for seven years before it was able to bring its innovative ETFs to market in 2006.

“Demand has been better than we would’ve estimated going into the business,” Sapir said.

ETFs that short Treasurys profit from higher yields

BOSTON (MarketWatch) — Leveraged exchange-traded funds that short U.S. Treasury bonds got a nice pop last week from a jump in yields, and the ETFs could see further gains if investors lose their thirst for government-backed debt.

In a dramatic sell-off Wednesday in government bonds, yields on 10-year notes surged above 3.7% at one point to their highest levels since November. That upheaval in the bond markets, which some traders said was exacerbated by mortgage-related selling, ignited fears that inflation is on the horizon as a result of the government’s efforts revive the ailing financial system.

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Other forces driving interest rates higher included worries there won’t be enough demand to meet massive auctions of Treasury bonds down the line, and hopes that the global economic picture may be brightening.

Nervous investors have piled into U.S. government debt during the credit crisis, sending yields to historic lows and sparking talk of a bubble in Treasury securities. Bond yields and prices move in opposite directions.

A mixture of unprecedented Treasury-bond offerings and government support to troubled financial institutions and banks “will cause the total amount of Treasurys and other government-backed debt to soar from roughly 25% of the total investment grade bond market in 2007 to 80% by 2010,” according to a recent report from investment manager BlackRock Inc.

“As a result, the fixed-income market today is dominated by lower-yielding government securities, and it is our view that it will remain this way until the demand for private borrowing picks up,” it added.

Bearish bond ETFs

Investors who short-sell securities are essentially betting that their prices will fall. The leveraged ETFs that short Treasurys have benefited this year as yields on 10-year notes have marched steadily higher since bottoming out around 2%. Investors hadn’t seen 10-year rates that low since the 1950s.

The ProShares UltraShort Lehman 20+ Year Treasury (TBT 50.73, 0.00, 0.00%) was up 51.4% this year through May 28, according to Morningstar Inc. The ETF aims for daily performance that is twice, or 200%, of the inverse return of a long-term Treasury bond index, minus fees and expense expenses. Launched in May 2008, the ETF has an expense ratio of 0.95% and holds more than $4 billion in assets. It is among the top ETF performers in 2009.

“A lot of investors think the next bubble is in Treasurys, so this ETF can let investors take advantage of that, or hedge their bond portfolios,” said Michael Sapir, chairman of the ETF’s portfolio manager, ProShares, in an interview. “It’s been a home run this year in terms of performance and assets.”

Despite the fund’s recent rally, it was hammered in late 2008 when stocks crashed while investors rushed into Treasury bonds and bid prices higher.

When using juiced-up funds such as the ProShares ETF, investors need to be aware that the leverage may not line up over longer intervals.

“Due to the compounding of daily returns, returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period,” according to ProShares. “Investors should monitor holdings consistent with their strategies, as frequently as daily.”

In volatile markets, long-term performance can become even more skewed, so the ETF might not be appropriate for buy-and-hold investors.

The Bethesda, Md.-based investment firm also oversees the ProShares UltraShort 7-10 Year Treasury (PST 56.12, +0.01, +0.02%) , which tracks an index with a shorter duration.

Meanwhile, competitor Direxion sponsors a pair of bearish ETFs that provide even more leverage at 300% on a daily basis: Direxion Daily 10-Year Treasury 3x Shares (TYO 68.96, -0.57, -0.82%) and Direxion Daily 30-Year Treasury Bear 3x Shares (TMV 76.89, -0.37, -0.48%) . The ETFs were listed in April.

Recognizing risks

Aside from the perils of leverage, investors should be cognizant of other specialized features of these ETFs.

“This fund does not enjoy the same tax efficiency as a traditional ETF,” wrote Scott Burns, Morningstar’s director of ETF analysis, in his latest report on ProShares UltraShort Lehman 20+ Year Treasury.

“This is due to the tax treatment of the derivatives, futures, and swap contracts that the fund uses to meet its mandate of providing inverse returns; all positions are marked-to-market at year-end, so capital gains cannot be deferred and profits are taxed as short-term gains,” he said.

Aside from these tax and credit-risk concerns, investors who are bearish on Treasury bonds can get hurt if deflation persists and investors shun risk. A rising U.S. dollar would also take a toll.

“Of course, for those thinking about shorting Treasurys, the ‘when’ becomes almost as important as the why.’ So keep the timing of these events in mind,” Burns warned.

There are other ETFs that investors can use to position for rising inflation and a weaker greenback.

For example, iShares Lehman TIPS Bond Fund (TIP 100.79, 0.00, 0.00%) and SPDR Gold Trust (GLD 91.25, 0.00, 0.00%) are seen as inflation-fighters.

Also, a host of currency ETFs such as PowerShares DB U.S. Dollar Index Bearish Fund (UDN 26.73, 0.00, 0.00%) let investors take a position against the dollar.