ETF Securities provide private investors a method of investing directly in commodities (ETFS Securities)

Name: ohingardail

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Product:	ETFS Securities
Date:	20/01/08 (639 review reads)
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Advantages: An easy method of including commodities in your investment portfolio

Disadvantages: ETFs and ETCs are a new idea, commodity investment always has been risky

ETF Securities (http://www.etfsecurities.com/) is a Jersey (UK) based company that can give private investors exposure to commodity markets. It issues shares called 'exchange traded funds' or ETFs that track commodity prices. You can buy ETFs that track gold, silver, platinum, iron, oil, corn, wheat or even lean hogs, or ETFs that track agricultural indices or hold a range (a 'basket') of commodities.

Such ETFs are also known as ETCs or 'exchange traded commodities'. Until ETCs were introduced it was very difficult for retail investors to get direct exposure to commodity markets.

Why invest in commodities?
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Before continuing, any reader must accept that this article cannot be used to provide investment advice, and nothing stated here should be taken as such. Anybody thinking of investing in commodities should understand that the value of a commodity investment can go down as well as up, and you could lose any or all of the capital you originally invested.

A 'commodity' is a tangible asset such as a metal, foodstuffs or fuel. Commodities are a different class of asset from stocks, shares, cash or property and as such can be a useful method of diversifying your investments and thus spreading your risk.

In times of economic volatility such as now, confidence in paper investments such as cash, bonds or shares tends to leach away because all these investment types are ultimately just promises, and have no real physical backing. This is why so many people in the UK have an instinctive preference to buy property, because property is a real 'thing' that you can get your hands on and is quite difficult to steal. But now, commercial and retail property values appear to be on the turn in the UK, and are well on the way down in the US. At least for the time being, property looks a poor investment.

Cash is supposedly the safest method of investment, yet the UK CPI (the official inflation rate) is running at about 2.1%, the old RPI is at 4% and the broadest PPI is running at a ghastly 11% (see http://www.statistics.gov.uk/instantfigures.asp). The Bank of England M3 money supply figure - one of many figures indicating how much money is being pumped into the system - is running at about 15% (http://www.bankofengland.co.uk/statistics/index.h tm). My guess as to what the real average inflation rate is would be somewhere between the RPI and the M3 values. This means that any cash deposit you have that pays less than (roughly) 8% after tax is actually losing value, because the value of the pounds in your account are going down faster than the interest is being added.

In addition to domestic inflation, the demand for basic commodities such as fuel and food is currently rising as emerging economies get richer and start importing commodities for consumption and construction. In a way, investing in commodities is a tangential method of investing in such emerging economies without the risk of getting involved in foreign stock markets.

This could all change, of course. Commodity investment is more speculative than most, at least partly because you cannot obtain returns (dividends) from them; they are inert 'things' not active businesses, and the only profit you can make is from their price appreciation, which in turn depends on the demand for or supply of the commodity in question.

Can ETFs be put into ISAs (UK only)?
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For those who don't know, ISAs or individual savings accounts are tax-free investment accounts available to UK residents. From April 2008 UK residents can put GB£7200 pa into an ISA, which optionally includes GB£3600 cash. Until this time, the overall ISA limit is GB£7000 of which only GB£4000 can be held in shares.

ETFs and ETCs are treated as shares like any other, so in principle they can be held in any shares ISA. Details may depend on your ISA provider, and I know that Hargreaves-Lansdowne allow them in their DIY shares ISAs.

If you are thinking of investing in gold through ETCs, bear in mind that physical gold investment in the UK is tax free anyway, so putting physical gold ETCs in your ISA may be an inefficient use of your annual allocation.

What's the difference between 'physical' ETCs and other types?
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Some commodities such as precious metals are easy to store; they don't take up much space and don't decay. ETF Securities offer physically backed ETCs for gold, silver, platinum and palladium (priced in either US$ or GB£). This means that ETF Securities have a store somewhere holding exactly the same amount of gold, silver, platinum and palladium as that issued through their physical ETCs.

For other commodities, such as lean hogs or wheat, they trade in commodity contracts or futures. Clearly, no self-respecting banker wants to become a farmer, although the idea of business-suited investment managers chasing hogs around a barn to keep them lean is an entertaining one.

The correlation between the spot price of a commodity and its physically-backed ETC will be much better than that between a commodity and its contract-backed ETC.

Also, physically backed ETCs carry no credit risk, whereas contract-backed ETCs carry the credit risk of those issuing the contract (the contract could in theory be reneged on, whereas physically held silver cannot).

Do ETF Securities ETCs pay dividends?
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N o. The only profit you can make is from the appreciation of the ETC price. Conversely, if the ETC price goes down you cannot be cushioned by dividend payments.

Fees
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Fees range typically from 0.39% pa (for physical gold PHAU) through 0.49% (for agricultural index AIGA). There may be exceptions to this range and full prospectuses are available to the public at the ETFS website.

Your share or ISA broker may have additional fees, for which you will need to contact them directly.

Risks
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ETFs are shares; their value may go down all the way to zero.

ETF Securities, ETFs and ETCs are fairly new and have not really been 'battle-tested' yet.

ETF Securities state on their website that if they ceased trading, the value of the ETCs they issued would not be affected.

Competition
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'ishares' (www.ishares.co.uk) are the most obvious competitor in ETF sales. They are issued from Dublin in the Republic of Ireland, which may lead to tax complications, and deal mainly in indices rather than commodities.

There are unit and investment trusts that provide exposure to commodity-related industries, such as mining, shipping or agriculture. In general, ETFs are cheaper that trusts because they merely follow an index; there is minimal management and hence minimal management fees.

Direct investment in tangential industries such as shipping and mining is another method of achieving similar aims, and here the risk is that you choose the wrong company in which to invest. Conversely, the gains when picking a mining company that finds a new seam of gold, for instance, could be far higher than investing in the gold itself.

There are several respectable methods of buying gold directly: BullionVault (http://www.bullionvault.com/from/OHINGARDAIL), the Perth Mint Certification Program (www.perthmint.com.au) or GoldMoney (www.goldmoney.com) for example. The Perth Mint and GoldMoney also offer silver investment services (although I believe that GoldMoney silver is 'unallocated,' that is, your silver purchase has no physical backing).

Buying stuff and burying it your garden is an option to be avoided unless your local economy is really at risk of disintegration. The costs for storage of bulky commodities would be high, and the insurance, especially for easily portable items such as gold coins, could be prohibitive. Professionally stored precious metals don't need exorbitant insurance as they are well protected, so it might be better to leave this to the professionals.

Links
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More about exchange traded funds : http://www.fool.co.uk/isas/information/exchange-tr aded-funds.aspx

More about ISAs : http://www.fool.co.uk/Your-Money/guides/ISA-Basics .aspx

Summary: ETF Securities are probably the only method open to private investor to invest in commodities