Commodities: Avoid or Add?

The national power grid is roughly 40% coal, 25% natural gas, 20% nuclear power and about 10% renewable sources. How is the move toward clean energy power changing the investment landscape? (Feel free to mention that Tesla’s Model S relies heavily on coal and a TONS tie-in.)

Although recent U.S. environmental regulations have gotten attention, the relatively low price of U.S. natural gas has caused as much or more destruction of domestic coal power demand than the regulations themselves. When and if that reverses, coal prices may rise, offering a way for one to play higher natural gas without the volatility of natural gas futures.

Even with the plant closings and environmental regulations, coal will remain a significant part of U.S. power generation. People tend to forget that some of our exciting newer technologies such as the Tesla Model S have really just transferred the power source from crude oil to electricity, a large part of which is generated by coal-fired plants. In addition, coal continues to help fuel growth in many fast growing economies such as India and China—which are also starting to focus on clean coal technologies.

In more mature economies like Europe, which has an expansive emission trading system in place, coal has maintained a strong foothold—part of this is because natural gas can be 4 to 5x more expensive then what we pay in the U.S. making coal a very competitive, low cost, and plentiful power source. I think the takeaway here is that coal isn’t going away anytime soon!

We created TONS to give investors direct access to this globally important energy source. TONS is the first ETP to offer exposure to coal futures prices. It is passively managed to be long the front calendar quarter of Rotterdam Coal Futures. Since coal represents almost 40% of global energy consumption and is the fastest growing fossil fuel for the last five years, we thought investors might be interested in including coal as a part of their energy allocation or to trade. In a funny way, TONS and Tesla are connected.

Many commodities are priced in U.S. dollars. Would owning commodities be another way to hedge against currency weakness?

Many studies have shown that commodities in general have significant correlations to currency prices. To the extent those correlations hold up they can certainly offer a hedge to someone wanting to protect themselves against a falling dollar or inflation. As your question states, this is simple math in that many commodities are priced in U.S. dollars and so their price will often move in the opposite direction of the currency all else being equal.

How are commodity ETPs taxed and what should financial advisors look for before jumping in?

At the end of each year the commodity ETPs’ futures positions are marked to market and taxed at 60% long term capital gains/losses and 40% short-term capital gains/losses. Any interest income is taxed as ordinary income. If an ETP is treated as a partnership, as TONS and GCC are, then these are passed through to the shareholder via a K-1.

Our K-1s are issued by the end of February so investors have plenty of time before their filing deadline. In a qualified tax-deferred account (i.e., 401[k], IRA, pension, etc.) the K-1 is more of a non-issue. From an investment advisor’s perspective they should understand whether or not an ETP is going to need to an issue a K-1 (it will if it’s a publicly traded partnership) so that their clients will be on the lookout for a K-1 before filing their taxes.