The JP Morgan XF Physical Copper Trust—a fund that is currently in registration at the Securities and Exchange Commission—would be the first ETF to be backed by physical copper, much like the SPDR Gold Fund (NYSEArca: GLD) holds gold bullion. But that’s if the fund ever makes it to market, especially now that a New York law firm filed a complaint with U.S. regulators on behalf of a copper merchant and copper fabricators, arguing that the copper trust would do more harm than good to the overall copper market by making crucial supply unavailable. U.S. Commodity Funds’ Chief Investment Officer John Hyland visited with IndexUniverse.com’s Cinthia Murphy to offer his perspective on what he says is a letter that shows how little the opposition understands ETFs and prospectus language instead of being able to actually identify real threats. Hyland is the brains behind the U.S. Copper Index Fund (NYSEArca: CPER), the first futures-based copper portfolio, which his firm made available to U.S. investors in November.

Murphy: The complaint in the letter was that the JP Morgan XF Physical Copper Trust would remove from the market as much as 30 percent of the copper available for immediate delivery worldwide, which would push prices up and “disrupt” the normal flow of copper trading by causing an artificial squeeze. Is that a fair assessment?

Hyland: That part of the SEC comment letter is just a scare tactic. You and I both know that how many shares an ETF registers for in their prospectus has zero to do with how many shares the fund will have when it launches. JP Morgan's most recent prospectus shows them registering 6.18 million shares. So what?

When I register funds, I often register anywhere between 50 million and 1 billion shares. The number really reflects how many shares the fund might issue over its lifetime, or at least over the first few years, and not the size on day one or the maximum number of shares outstanding at its peak. When, or if, this fund launches, it will start with no fewer than 100,000 shares worth $7 million [100,000 shares is the NYSE minimum to list], and maybe a maximum of 500,000 shares, worth maybe $35 million.

Note that if an ETF that is a 1933 Act fund registers 50 million shares, and then has an initial wave of creations of 4 million, it now has 46 million unissued left. But if it redeems 2 million shares each month over each of the next 12 months, and creates 2 million more later in the same month, it will end the year still with 4 million shares outstanding, but now with only 22 million unissued shares remaining. So an ETF always needs to register a lot more shares than it ever has outstanding at any one time.

Murphy: Will this fund receive massive amounts of inflows that will cause physical holdings of copper to shoot upward?

Hyland: I doubt it. Copper is not gold, and few, if any, investors feel a compulsion to own it in the physical form unless a compelling financial opportunity arises.

Since this fund will earn you the spot movement of copper minus fund costs and minus what are likely to be hefty storage costs—maybe 3 percent annual combined expense—it is not clear that people will flock to this fund unless copper futures are in steep contango. I think it will have a certain user base, but I doubt it becomes a big fund. Copper futures are most of the time easier and cheaper to use to invest.

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