Momentum Trading In Commodities Is Made Easy With ETFs and ETNs

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February 18, 2010 2:57pm ETF BASIC NEWS NYSE:COW

commodities

Commodity futures have always provided speculators opportunities for substantial profit. That’s, of course, the lure of this risk transference market. By shouldering the price risk


that commercial users and producers wish to shed, speculators get a shot at making leveraged gains, if they can correctly forecast price movements.

But the volatility in commodity prices generally precludes a “buy-and-hold” approach to futures. Commodity accounts are marked to market each day. Cash flows from loser to winner, which leaves little cushion for customers who are highly margined. When only 3 to 5 percent of a contract’s value is put up as a performance bond, margin calls aren’t such remote possibilities.

Nowadays, however, investors can also tap into commodities through their securities accounts without having to subject themselves to the vicissitudes of margin trading. Exchange-traded products, in the form of futures-holding funds, structured notes and grantor trusts, now permit access to enough individual commodities that a savvy investor can build a diverse portfolio capable of capturing longer-term cyclicality.

In fact, the past year has been particularly fruitful for commodity traders. Well, let me rephrase that. It’s been good for commodity investors. You didn’t have to trade frequently to reap some substantial gains over the past 12 months.

Take a look at the table below, which recaps the performance of 14 narrowly focused exchange-traded products. Overall, these securities earned an average 29 percent return since February 2009. Futureslike? Maybe, maybe not. Some traders scalp for relatively small gains; others try to capture profits more slowly with spread trades.

 

ETP

 

Type

Feb. 1

Price

10-Mo.

MA

%

+/- MA

12-Mo.

Return (%)

iPath Sugar (SGG)

ETN

$77.53

$66.78

16.1

66.5

iPath Copper (JJC)

ETN

43.95

39.21

12.1

103.5

iPath Platinum (PGM)

ETN

36.94

33.60

9.9

40.5

iPath Cotton (BAL)

ETN

36.40

33.51

8.6

47.9

SPDR Gold (GLD)

Grantor Trust

109.02

101.4

8.1

18.3

iPath Cocoa (NIB)

ETN

46.76

45.71

2.3

25.3

U.S. Gasoline (UGA)

ETF

35.06

34.25

2.3

49.9

iShares Silver (SLV)

Grantor Trust

15.82

15.60

1.4

22.8

U.S. Oil (USO)

ETF

37.77

37.46

0.9

39.7

iPath Livestock (COW)

ETN

28.35

28.19

0.6

-9.8

U.S. Heating Oil (UHN)

ETF

25.79

25.82

-0.1

33.1

iPath Coffee (JO)

ETN

36.99

38.97

-1.0

2.6

iPath Grains (JJG)

ETN

37.80

38.18

-5.1

9.1

U.S. Natural Gas (UNG)

ETF

9.73

11.23

-13.4

-43.8

Many investors, including large-scale money managers, are momentum followers. If you know where the momentum thresholds are, you can often identify areas where heavy buying and selling are likely to occur.

In our Desktop columns, we often use 200-day moving averages to identify long-term support levels for futures contracts or cash metals markets. Similarly, we can use 200-day, or 10-month, moving averages to quickly identify analogous areas for commodity ETPs. Momentum traders, of course, use all sorts of moving averages – some short, others long – but a 10-month average is broadly thought to be critical in determining a market’s long-term trend.

Note, for example, how the iPath Dow Jones-UBS Livestock Sub-Index ETN (NYSE Arca: COW) is presently scraping along, just on the upside of its 10-month moving average. Livestock hasn’t fared well over the past year, but as we noted in “Is Meat A Hard Asset?”, the cattle market’s prospects seem to be brightening on increased wholesale demand. The ETN’s 10-month moving average could very well represent a launchpad for a bullish turnaround.

Products trading on the downside of their 10-month averages also warrant attention, if for nothing else than to identify the direction of their present price momentum. Take the natural gas ETFthe United States Natural Gas Fund (NYSE Arca: UNG)—as an example. Its current discount to its moving average is sizable, but it has been shrinking. At some point, it may even cross to the upside of the average. At that point, momentum traders would regard it as a potential purchase candidate.

That said, trading on the basis of a moving average isn’t likely to put you in front of a trend. It’s essentially a lagging indicator. When used as a trading signal, it’ll likely put you in the middle of a trend.

But what’s wrong with that? After all, the trend is your friend, isn’t it?

Written By Brad Zigler From Hard Assets Investor

 

 

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