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Investing in exchange-traded commodities

INVESTMENT GUIDE: Now you can invest in commodities in sterling, or take exposure to forward prices
October 31, 2007

New exchange traded funds (ETFs) have been launched, offering British investors access to commodities in sterling and ways to speculate on future commodity price movements.

Last year, 19 new Exchange Traded Commodities (ETCs) were launched by ETF Securities. Ten of these are simply sterling versions of products that have been listed on the London Stock Exchange (LSE) since last year, including a gold ETC. With these new funds, however, you will no longer have to factor the weak dollar into your returns. The remaining 9 offer something quite unusual.

For the first time, you can now gain exposure to futures prices through an index tracking fund. All the ETFs are linked to the Dow Jones-AIG Commodity 3 Month Forward Indices (see list below). If you get it right, playing the futures market allows you to make smaller losses or greater gains, and, of course, vice versa if you get it wrong. This is because these indices track the price of longer-dated futures contracts. If the price of the futures contract is below the current 'spot' price of the commodity, the futures price could rise to converge with the market price as it approaches expiry. This is known as "backwardation", and can provide an additional uplift, on top of any rise in price of the underlying commodity, rather like an investment trust that is bought at a discount that subsequently narrows. The opposite, when the futures contract is more expensive than the spot price, is called "contango".

The 9 Forward ETCs listed last month include a range of broad indices such as commodities, soft commodities and livestock, but a further 19 funds are due to launch in the coming weeks. These will allow you to gain exposure to single hard and soft commodity futures prices including copper, cotton, soybeans and wheat.

With commodities prices still booming – coffee is at a 10 year high, gold is at a 28 year high, oil costs over $90 a barrel, up 40 per cent in the last 12 months, and platinum is at an all time high – these ETFs are an interesting new way to play a sector that shows no signs of slowing.

But it's not just futures contracts that can be accessed for the first time through ETFs. iShares, the largest issuer of ETFs in the UK, has launched a fund that invests in timber and forestry. The iShares S&P Timber and Forestry ETF tracks the performance of the 25 largest listed companies in the timber and forestry industry, ranging from timber real estate investment trusts (Reits) to paper packaging companies. According to iShares, timber not only has a low correlation with other asset classes but has returned over 70 per cent since 2002. This ETF is an excellent, simple way to gain exposure to a sector that is otherwise hard to access. It joins the iShares S&P Global Water, iShares S&P Clean Energy, iShares S&P Private Equity and iShares FTSE/Macquarie Global Infrastructure 100 in the company's alternative product suite.

ishares has also launched a Latin America ETF, giving access to many of the resource-rich region's fastest growing economies. Yet another issuer of ETFs, Lyxor has also launched four emerging markets ETFs, giving exposure to the Brazilian, Russian and Chinese markets – three of the four much vaunted BRIC economies – and Asia Pacific (ex Japan). While there are already Brazilian and Chinese ETFs listed in London, this is the first to offer exposure to Russia. This is also the first time that UK investors can access the whole Asia Pacific (ex Japan) region, including Australia and New Zealand, in a single listed share.

The new forward index ETCs

Forward All Commodities

Forward Agriculture

Forward Energy

Forward Ex-Energy

Forward Grains

Forward Industrial Metals

Forward Livestock

Forward Petroleum

Forward Softs

Upcoming issues:

Aluminium, Coffee, Copper, Corn, Cotton, Crude Oil, Gasoline, Gold, Heating Oil, Lean Hogs, Live Cattle, Natural Gas, Nickel, Silver, Soybean Oil, Soybeans, Sugar, Wheat, Zinc.

Existing ETCs now available in sterling:

Agriculture

All commodities

Grains

Natural Gas

Gold

Physical Gold

Physical Silver

Physical PM Basket

Brent 1 month

WTI 2 month