[miningmx.com] — COMMODITIES are the hot story, both overseas and in South Africa on the JSE. As commodity prices – such as gold, silver and oil – set new price records on a regular basis, retail investors will be looking for exposure to them. But not necessarily through commodity producing companies, which have often proved to be poor investments.
Direct exposure to gold is probably easiest, through coins such as the Krugerrand or the very popular exchange-traded fund NewGold, which tracks the physical rand price of gold. Buying other commodities directly is a little more difficult. You could probably store a few hundred barrels of Brent crude at home – the barrels make useful bedside tables – but something like coal is more difficult – unless you live near a railway station and can store a few coal trucks in the garden to the delight of your neighbours.
By far the easiest and most efficient way for retail investors to gain direct exposure to commodities is through futures contracts, or typically the number of exchange-traded notes (ETNs) that have been listed on the JSE. In most cases the ETNs are fairly affordable and can be traded just like shares on the JSE.
Latest to join the growing list is the Rand Merchant Bank Coal ETN. It’s probably the most interesting of all the ETNs listed so far, taking advantage of the strong demand for coal from countries such as China and India. That demand has been boosted by the near collapse of the Australian coal exporting industry following the floods in Queensland earlier this year. SA has 3,7% of the world’s coal reserves and 4% of global production, making it the largest coal producer in Africa.
The RMB Coal ETN invests in Richards Bay Coal Futures contracts. The port in KwaZulu-Natal is the largest base for coal exports and its coal terminal the world’s largest single coal export facility.
A single unit of the RMB Coal ETN gives an investor exposure to one tonne of coal. The current market price is around R823/unit. The investment includes interest at US Treasury bill rates, the exchange rate as the RMB Coal ETN trades in rand and the price of the futures contract.
“We’ve tried to make the ETN accessible to retail investors. The 95 basis points annual fee is seen by some as expensive, but we have to charge that because coal is harder for us to trade. We have to carry the price risk until we can hedge,’ says Vicki Goodwin, of RMB. To give an idea of the price risk, a futures contract in coal typically trades at 5,000t. The big attraction for retail investors is being able to invest in a single tonne at an affordable price.
At year-end 2010 RMB launched an oil ETN, in which trade is said to be brisk. The ETN offers investors exposure to the front month futures contract for light sweet crude oil, listed and traded on the New York Mercantile Exchange. A single unit, which currently costs around R631, gives an investor exposure to one barrel of oil. Futures contracts typically trade in 1,000 barrels.
“ETNs have proved very popular globally and RMB’s industrial commodity ETNs are a first for SA, allowing investors direct exposure to some of the underlying commodities driving inflation,’ says Bevan Jones, head of energy and metals at RMB. “ETNs have a low cost base, they’re transparent, liquid and offer accessibility to a wide range of investments that may otherwise be unavailable to investors.’
The RMB Oil ETN has an investor fee of 75 basis points. That’s still higher than the average annual cost of an ETN, but the commodity ETNs give direct exposure to a fairly unique asset class for retail investors.
Standard Bank was first off the ETN mark last year with the listing of four precious metal ETNs, tracking gold, silver, platinum and palladium. Units give the investor rand exposure to an ounce of the precious metals. Standard Bank lists two advantages it sees in commodity ETNs. “Extensive research has shown commodities have proved to be a successful investment tool to provide increased returns and significant diversification benefits when included in an investor’s portfolio. In addition, the inclusion of commodities also provides protection against inflation superior to that of other conventional asset classes.’
The second point is perhaps the most important. One thing we’re all pretty sure of is that SA’s inflation rate is going to increase. Some forecasts say it could hit 7% to 8% by year-end 2011. Conventional wisdom is to invest in shares that will benefit from rising inflation as an inflation hedge. But that’s not always easy. Often the shares that should benefit from inflation, like the retailers, behave in perversely different ways.
Buying direct exposure to a commodity driving inflation – oil is probably the best example – is a sure way to obtain an inflation hedge. And diversification is also important. Though also listed on the JSE, ETNs will behave differently to shares under different market conditions. The commodity ETNs offer investors with a particular view on one or two commodity prices about the best entrance they can get to that commodity.
Just as ETFs are starting to challenge unit trusts as a lower-cost investment, ETNs are likely to join the stable. The notes open up a new asset class that can’t be replicated by shares.
– The article first appeared in Finweek
