The Ag ETF Price Disconnect
July 12, 2012
With historically hot and dry weather, agricultural commodities prices have been on fire since the beginning of June, but ETF investors have been left out in the cold.
As the crack team at our affiliated website, HardAssetsInvestor.com, has been chronicling, agricultural commodities prices are soaring. In fact, corn prices were “limit-up” earlier this week.
The culprit is a heat wave the likes of which we haven’t seen since 1982, and the resulting expectation of production declines, but the returns to ETF investors have been lukewarm at best. What gives?
ETF investors don’t get spot prices.
Stop me if you have heard this before, but I will say it again: ETF investors in commodities don’t get access to the spot market. In fact, they don’t even get access to the front-month futures contract on the commodities.
I realize this comes as little surprise to loyal readers of our blogs, but the contrast between the performance of spot corn, soybean and wheat prices and their ETF counterparts has been striking.
What’s perhaps even more interesting is that ETF investors in single-commodity agricultural ETFs don’t even get access to the front-month futures contracts on those commodities.
Take a look at the chart below which shows the performance of the front-month contract of the three popular agricultural commodities mentioned above—corn, wheat and soybeans.
To borrow a sports analogy, those are video game numbers: corn up 43 percent since June 1; soybeans up 24 percent; and wheat up 32 percent. Now take a look at the performance of the ETFs covering these commodities.
The Teucrium Corn Fund (NYSEArca: CORN) has been the best performer of the lot, but even its 33 percent rise since June 1 is 10 percentage points worse than the performance of the active contract on the commodity.
The Teucrium Wheat Fund (NYSEArca: WEAT) has lagged its front-month contract by 12 percentage points, while the Teucrium Soybean Fund (NYSEArca: SOYB) has lagged the active contract on soybeans by 6 percentage points.
The broad agricultural commodity ETN, the PowerShares DB Agriculture Fund (NYSEArca: DBA) is only up 15 percent over that period despite the fact that nearly 50 percent of its index covers corn, wheat and soybeans.
The reason for that has to do with the awful performance of lean hogs and cattle prices, but the reason for the lagging performance of CORN, SOYB and WEAT has to do with the nuances of Teucrium’s index methodology.
Since we know that investors can’t and don’t invest in the spot price of the commodity, the closest they can get is in the front-month futures contract.
These contracts are the best available measure of spot prices in these commodities, but CORN, WEAT and SOYB don’t hold these contracts. Instead, they own three different contracts farther out on the futures curve.
In a way they make a trade-off.
Instead of giving investors access to the short-term price movements of front-month contracts, they position you for the longer term.
In periods of extreme contango, this will likely benefit investors, but in periods of backwardation that are accompanied by big short-term price increases, like we are currently seeing in corn and soybean prices, it will cost investors.
So while investors may have timed the market perfectly, buying CORN or SOYB back in June, that does not mean they get to participate in the sharp run-up in the spot market for those commodities. That dichotomy is another stark reminder that investors must understand exactly what they are buying.