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Storing Oil in your Basement…Is There a Better Way to Access Commodities?

Contrary to some investors’ beliefs, buying a 55 gallon drum of oil is the only way to ensure you get direct exposure to the price of oil. This is also true for other commodities such as wheat, natural gas, cattle, and precious metals. Not all of us have back yards big enough for cattle to graze, safes secure enough to store precious metals, or basements large enough to hold drums of oil. Instead, investors use exchange traded funds or mutual funds to gain access to commodities.

The drawback of using exchange traded funds and mutual funds is that they don’t provide direct exposure to the spot price of a commodity. Instead, managers get their exposure through futures contracts from the futures market. A futures contract is an obligation to take or give delivery of a commodity at some point in the future at a price agreed upon at the inception of the contract. For example, the price of oil today may be $95, but the futures price for a 6 month contract could be $100. Under those contract terms, an investor needs the price of oil to reach $100 just to break even on the investment. This dilemma of futures prices being higher than the expected spot price is also known as contango. In the 12 months ending July 31st, paying a premium for futures contracts has caused commodity investors to trail commodity prices by 3.9%. (difference in total performance return between the DJUBS index and the DJUBS spot price index, Bloomberg)

Price appreciation isn’t the only source of return when investing in the futures market. Entering into a futures contract requires the seller to post collateral for the investment, which may be invested on the buyer’s behalf. Typically, the collateral is invested in short-term high credit quality instruments such as US Treasury bills. Historically low Treasury yields results in one source of futures returns also being historically low.

The higher future price hurdle coupled with historically low collateral yields presents two obstacles in the commodity investing environment, especially for those who aren’t ready to commit their home to storage space for their investments.

 

Important Disclosure Information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable. Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request. This article is not a substitute for personalized advice from RegentAtlantic. This information is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

Index Definitions:

  • DJUBS Index- The Dow Jones-UBS Commodity Index is a broadly diversified index that allows investors to track commodity futures through a single, simple measure. The index is composed of futures contracts on physical commodities. The index is designed to minimize concentration in any one commodity or sector. It currently includes 19 commodity futures in five groups. No one commodity can comprise less than 2% or more than 15% of the index, and no group can represent more than 33% of the index (as of the annual reweightings of the components).
  • DJUBS Spot Price Index- The Dow Jones-UBS Commodity Spot Index is a broadly diversified index that allows investors to track commodity futures prices. The index is composed of futures contracts on physical commodities. The index does not account for the impact of rolling futures contracts or the costs associated with holding physical commodities. The index is designed to minimize concentration in any one commodity or sector. It currently includes 19 commodity futures in five groups. No one commodity can comprise less than 2% or more than 15% of the index, and no group can represent more than 33% of the index (as of the annual reweightings of the components).

Important disclosure information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.

Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.

This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.

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