Since its launch in 2004, the SPDR Gold Shares exchange-traded fund has enjoyed miraculous success in attracting investors. In just seven years it has ballooned to a market capitalization of $54.2 billion, becoming the second-largest ETF in the 1,100-fund ETF universe, behind only the venerable SPDR S&P 500 Trust.
Now investment firms are betting that the same logic behind SPDR Gold Shares — creating an ETF with physical holdings of metal instead of futures contracts — can be repeated with industrial metals like copper. But analysts are raising concerns that large-scale hoarding of metals widely used by industry could shrink scarce supplies and drive up prices. “How much material is available to the market has been the key driver of price,” says Daniel Major, a commodities analyst with Royal Bank of Scotland Group in London. “If you remove a lot of that material, it has the potential to have an impact on fundamental supply and demand.”
So far only one ETF, offered by London-based ETF Securities, features physical holdings of copper. But New York–based BlackRock and JPMorgan Chase & Co. have both filed plans with the Securities and Exchange Commission to introduce physical copper ETFs in the U.S.
The rationale for these offerings is obvious: Like gold, copper has enjoyed a huge run in recent years. The metal traded for about $3,000 a ton at the beginning of 2009 and has since tripled in value, to about $9,500, briefly crossing the $10,000 threshold in late 2010. What’s more, producers in places like Australia, Chile and Indonesia can’t keep up with demand. The market needs some 20 million tons a year — 40 percent of which will be consumed by China — and producers can only mine about 19.5 million tons, by some estimates. Add in financial speculators, and the market could soar.
“If JPMorgan and BlackRock bring another 180,000 tons of investment demand, I think the market would have a hard time holding a price from where we are now,” says a metals analyst at a large New York hedge fund.
Many believe precious-metals funds have already demonstrated their ability to move prices. “If there hadn’t been the sort of retail investor uptake in gold ETFs, then I am most certain that there would have been more gold supply, and that would have been negative for pricing,” says RBS’s Major. He notes that gold ETFs now hold about 2,100 tons of bullion, about 80 percent of annual world production.
Jason Toussaint, managing director for investment at the World Gold Council, which manages the SPDR gold ETF, disputes the fund’s influence on prices. Toussaint maintains that gold ETFs account for only 7 percent of world gold demand and that jewelry markets in China and India are more important. “It has become a significant factor, but not the leading factor, in driving the gold price,” he says of ETFs.
Although BlackRock and JPMorgan haven’t disclosed what they will charge for managing their ETFs, it’s likely to be much more than any precious-metals ETF manager currently asks. One problem is storage: A ton of gold is worth $50 million, while a ton of copper is worth only $9,500. Therefore the vast warehouses needed for copper will be far more expensive than gold vaults.
Another problem from investors’ perspective is that the physical commodities funds were designed to help overcome a long-standing difficulty that had bedeviled the futures markets: roll risk. Because gold and silver have upward-sloping futures curves, there’s a loss each time a futures contract is rolled over — a problem known as “contango.” But copper often has the opposite issue, so it’s more advantageous for a speculator to buy copper futures than to own the physical metal.
Perhaps this helps explain why ETF Securities’ copper ETF, which is not offered in the U.S., has gotten off to a slow start. In fact, it has grown only marginally after three months on the market. In contrast, when the firm launched a platinum ETF a year earlier, it grew by 62 percent in just three months.
Daniel Wills, a senior analyst at ETF Securities, says industrial metals may appeal less to retail investors because “they do tend to have a high level of volatility of returns, and it does require a little bit more specialist knowledge.” Wills thinks retail investors will be more attracted to ETFs that offer a “suite” of metals, such as the firm’s successful basket of gold, silver and platinum.
Mariana Bush, a Washington-based analyst at Wells Fargo Advisors who specializes in ETFs, wonders if there’s a market for all of the metals ETFs that are in the pipeline. There are already five gold bullion ETFs in the U.S, with $72 billion in assets, Bush notes, along with three silver and four other precious-metals offerings, including one that mixes the “white metals” of silver, palladium and platinum. “That could expand more, I guess, but we already have several options,” she says.
