Commodity ETFs: A Big Advantage Over Commodity Based Stocks…
I’ve been talking about the advantages of commodity ETFs over the past few weeks.
First I laid out the underlying thesis for adding commodity exposure to your portfolio in the first place. Then I proposed why commodity ETFs are a far better alternative to risky and complicated futures contracts and options.
But what about commodity-based stocks?
If you’re looking for a certain commodity to rise, is it a good idea to buy shares of a resource-producing company to capture gains in the underlying commodity?
For example, you may think the price of natural gas is going to rise so you purchase shares of Chesapeake (CHK), the largest gas producer in the US.
To answer that question, let’s first cover the basics of buying a stock…
First of all, buying CHK gives you percentage equity ownership of the company.
Now, as with most large companies, there are different classes of CHK stock – preferred and common. In most cases, preferred stock comes with a guaranteed dividend. Obviously, accruing monthly or quarterly income is a great benefit for long-term investors.
However, most retail investors sink their money into common shares. Common stock may or may not have a dividend attached to them. What’s more, common stock dividends (if they have one) are not guaranteed. In other words, Chesapeake could lower or erase their common stock dividend (currently 1.7%) should they choose.
Now let me be clear…
I won’t argue that there are distinct long-term advantages to holding stocks paying you a dividend. Compounding interest in a very powerful long-term investment force.
However, don’t expect the share price of resource producers to correlate with the price of the commodity they produce in the short-term. In other words, don’t be surprised when you find CHK is drastically underperforming the price of natural gas right now.
Take a look…
As you can see, the price of natural gas is up a staggering 20% since late February 2013. Yet Chesapeake shares are essentially flat over the same period.
Why’s there such a huge divergence in performance?
Quite simply, Chesapeake has a lot of company-specific issues. And of course, Chesapeake isn’t the only company with behind-the-scenes problems and uncertainties. It’s that way with all resource-based stocks.
It all comes down to this…
Trading stocks in companies that produce a certain commodity is not a pure price play on the commodity. Company-related issues will throw a wrench in the trading correlation between resource-based stocks and the commodity they produce nearly every time.
As a result, the best way to capture profits in commodities is to buy the actual commodity itself.
And as I’ve explained in previous articles, the easiest way to do that is through commodity ETFs!
For example, you could have purchased the US Natural Gas Fund (UNG) and captured the bullish March move in natural gas tick for tick!
So if you’re looking for short-term commodity profits, look no further than commodity ETFs. At Commodity Trading Research, we work hard to uncover the most profitable commodity ETF opportunities the markets have to offer.
See you again soon!
Until Next Time,
Justin Bennett
Category: Commodities
