We’ve written about commodity ETFs before… and update our readers regularly on just how much investors in such ETFs underperform a simple strategy of just buying the December futures contract and rolling it annually. But our reservations notwithstanding, the commodity ETF market has continued to grow, leading to products like Proshares leveraged commodity ETFS. Late last year they launched two new Natural Gas ETFs – Ultra DJ-UBS Natural Gas (BOIL) and UltraShort DJ-UBS Natural Gas (KOLD).
In our opinion, the only thing worse than getting commodity exposure via an ETF is doing so in a leveraged fashion, with these ETFs leveraged to provide 2x the return (long or short) of the Dow Jones-UBS Natural Gas Subindex (DJUBSGN). Our other beef is that commodity ETFs only give you a one directional bet (up), and don’t attempt to control risk at all. You are simply long and wrong when and if there is a commodity market correction (rather common place, especially in Natural Gas). Insert your favorite analogy here (like a car that doesn’t go in reverse, playing golf with just one club, getting on a plane which has no landing gear and must always go up, etc.)
It looks like ProShares got part of this message by releasing an offering which tracks the short side of Natural Gas – but that is just the same mistake in reverse. It still goes in just one direction (they have fixed the car which only goes forward by releasing a new model which only goes in reverse).
The bigger picture is that as ETF’s become more popular, they are branching into alternatives. But just because an ETF on Natural Gas (or any other commodity) can be built in a day doesn’t mean it’s a good idea for anyone. Remember that long-only and short-only ETFs put the onus on investors (or their advisors) to manage the risk, size their bets, and reallocate when prices go the opposite direction (quick everyone, get out of this car, and into the other car – we’re now going to go into reverse).
And Natural Gas… For retail investors? Really? While it is just a shadow of its former volatile self, one need only look up Amaranth Advisors to remember just how much bite this market can have. Even seasoned investors have been sunk gambling on one side of Natural Gas price movements.
What about instead of a long-only or short-only ETF, there was some sort of alternative which reacts to prices – going long when they are trending higher and short when they are trending lower? And what if there were professionals making those decisions on whether to go long or short? Or, better yet, professionals designing computerized models which track historical prices to determine the best entry and exit points on both the long and short side? Oh, right – that already exists – and it’s called managed futures.
That, in our opinion, is the right way to get commodity exposure – not double leveraged bets on one direction or the other.