You’re convinced that commodity prices will continue lower, so how do you profit from that move? Inverse exchange-traded funds (ETFs), futures and options on futures provide direct exposure to price movements, but before taking a position investors should consider whether to trade a broad market index or focus on specific markets.
Graham Day, CFA, director of product development and sales at Elkhorn Investments in Wheaton, Illinois, cautions that individual commodities don’t always move in sync and shouldn’t be treated as a single market. He cites higher prices in cattle and cocoa, both of which have had strong performances over the past three years, as examples. “You have to be able to look at individual commodities because there’s always going to be pockets of opportunity,” he says.
Many investors are familiar with taking long positions in exchange-traded funds (ETFs) so doing the same with inverse ETFs can be a natural choice. According to Zacks Investment Research, 20 inverse ETFs for commodities were available as of mid-September. The funds covered both indexes and focused markets, such as agriculture, precious metals, gold miners and industrial metals. All the inverse funds showed positive returns for the past 12 months, ranging from 8.9% for the DB Gold Short ETN (DGZ) to 300% for the VelocityShares 3x Inverse Crude Oil ETN (DWTI).
Inverse ETFs offer convenience, says Carley Garner, senior futures market strategist and commodity broker with DeCarley Trading in Las Vegas, Nevada, and author of “A Trader’s First Book on Commodities.”
Most investors with access to a stock trading account can trade these funds but they may need to take an extra step or two beforehand. Fidelity Investments, for instance, offers trading of inverse ETFs but customers must agree first to the terms of Fidelity’s Designated Investments Agreement, which covers things like risk tolerance and requires customers to have the appropriate investment objective.
Inverse ETFs also have drawbacks. The small number of funds and the limited coverage of specific commodities restrict investors’ choices. ETF tracking errors and technical factors like futures contract rollovers can also affect returns relative to the underlying commodity. “Sometimes you can be dead right on the direction of the commodity but the ETF doesn’t really follow through as far as your profits and losses,” says Garner.