A Big Secret Every Commodity ETF Investor Must Know…
No doubt about it, commodity ETFs make it easy for the average investors to capitalize on price swings in various hard assets.
For example, if you’re feeling silver is undervalued and ready to rise, you could purchase shares of the iShares Silver Trust (SLV). If silver shoots higher, your SLV shares gain in value since they trade in lockstep with the underlying metal.
Once the metal achieves your price target, just tap the sell button and collect your profits.
How can it get any easier than that?
Of course, the best part about the above scenario is the fact you didn’t have to open a futures account to profit from a rise in the price of silver. That’s because you can trade commodity ETFs from a standard brokerage account.
What’s more, you didn’t have to learn the complicated world of commodity futures trading… and accept the increased risk of such an endeavor.
But as easy and efficient as commodity ETFs are, they do have a few quirks.
And I’m going to show you a big one right now…
When you’re investing in commodity ETFs, you need to understand the concept of Net Asset Value (NAV). NAV is simply a measure of the funds assets minus its expenses and liabilities. In the case of most commodity ETFs, the NAV per share is usually very close to the share price of the ETF.
But not always…
In some circumstances, the share price of a commodity ETF can become inflated relative to the actual NAV of the fund.
In other words, shares will trade at a premium to what the fund is actually worth.
Obviously, this is a situation you want to avoid since you’re buying shares that are blatantly overvalued. When the premium comes out of the shares (which it always does), you’re virtually guaranteed to lose- even if the price of the underlying commodity goes up!
Here’s the perfect example…
In early 2012, the iPath DJ-UBS Natural Gas (GAZ) started trading at an enormous premium to its net asset value.
Take a look…
Thanks to a misstep by the fund’s managers, GAZ shares skyrocketed, sucking in unwary investors in the process. If these investors had checked the fund’s website, they would have realized that the ETF was a ticking time bomb.
And explode it did!
Compare the chart of GAZ above to a chart of natural gas below and you’ll truly understand what a disastrous situation this was.
As you can see, natural gas is up nearly 100% from early 2012 while GAZ lost over 50% of its value. Anyone buying GAZ in hopes of timing a bottom in the natural gas market was in for one heck of a surprise.
Folks, this is why it’s important to check the sponsoring company’s website for the fund’s NAV (sometimes it’s called Daily Indicative Value). If shares are trading at a premium of 5% or higher, look for better commodity ETF alternatives.
Finally, as with any investment, it’s always a good idea to read the prospectus of any commodity ETF you’re thinking of investing in. Understanding how the fund tracks the underlying commodity is important, and it can give you an edge in your investing.
Until Next Time,
Justin Bennett
Category: Commodities
