Jared Cummans: Commodity investing has surged in recent years, as investors have discovered the diversification benefits associated with low-correlated hard asset exposure in their portfolios. But with commodity investing also come the dangers of contango, as a number of traders fall prey to this phenomenon every day. By definition, contango is the process whereby near month futures are cheaper than those expiring further into the future, creating an upward sloping curve for future prices over time. The reason behind this is most often attributed to storage costs; storing barrels of oil or bushels of corn isn’t cheap and the costs have to be passed down the line. Some commodities, like natural gas (NYSEARCA:UNG) and crude oil (NYSEARCA:USO), are known for exhibiting steep contango over time, while others may never show signs of this phenomenon [see more at What Is Contango?].
One of the reasons that commodity investing has become so popular is its adoption into the exchange traded world, as there a number of products that now offer exposure that was hard to come by beforehand. Now, investors gain access risky futures contracts without the hassle of a futures account and all of the risks associated with them. But while ETFs mitigate some risks, they also bring on others. The most popular commodity ETFs are first generation products that feature an automated roll. This means that every month, the fund automatically sells the current contract and buys the next nearest maturity. If a commodity is in contango, this roll process automatically erases value for the fund [see also Understanding Contango: Natural Gas Example].
Many investors are quick to overlook this behavior and end up getting burned. The most important thing to remember about these products is that they should be thought of as a futures contract first and an ETF second, no matter what structure they come under. But the news is not all bad; there are a number of products that actually prey on contango and count on it to make profits. Below we outline five funds that count on contango and can help you profit from this investing taboo [see alsoIs Gold Still A Safe Haven?].
- UltraShort Silver (NYSEARCA:ZSL): ZSL is an investor favorite, as it is home to over $200 million assets (a fair amount given that it is primarily a trading tool) with a daily volume topping 620,000. This fund takes a -200% position on silver bullion, allowing precious metals bears to make handsome profits over certain time periods. Its inverse strategy also implies that it will benefit from contango-related loss. The fund is down on the year, but for the trailing three months it has gained 35%.
- UltraShort DJ-UBS Crude Oil (NYSEARCA:SCO): Another -2X fund, SCO has been hot in recent days as crude oil has been slipping in markets. The fund trades over 1.3 million times on a daily basis and is able to profit from contango given its inverse strategy.
- DB Gold Double Short ETN (NYSEARCA:DZZ): The first ETN on the list, DZZ applies a -200% leverage to gold futures, giving it a nice appeal in the short term as gold has seemingly lost all momentum. Again, contango is a plus for this fund, and gold is currently contangoed through 2017.
- E-TRACS Natural Gas Futures Contango ETN (NYSEARCA:GASZ): This fund utilizes a unique strategy by taking short positions in near-term natural gas futures while taking long positions in contracts who’s maturity is further out. That allows GASZ to profit from contango, an environment in which natural gas is sitting through 2020. While NG has gotten slaughtered on the year, GASZ is up roughly 10%.
- 3x Inverse Natural Gas ETN (NYSEARCA:DGAZ): This fund has made quite a splash this year, as it has been incredibly volatile given the behavior of natural gas. Its -300% leverage makes an ideal play against contango, but if NG continues to gain momentum as it has in recent weeks, investors may do well to hold off on this fund.
Written By Jared Cummans From CommodityHQ Disclosure: No Positions.
CommodityHQ offers educational content, analysis, and commentary on global commodity markets. Whether you’re looking to speculate on a short-term jump in crude or establish a long-term allocation to natural resources, CommodityHQ has the information you need.