Reader Question On Soft Commodities

Dean asks, “if one wanted to invest in Grains, what symbols [do] you recommend?”

I don’t know if I would necessarily recommend any symbol. The two stocks that I am most familiar with in this arena are the Rogers Agricultural Index (RJA) and the PowerShares DB Agriculture Fund (DBA). I once owned RJA so let’s start with that one first.

RJA is an ETN designed to track the (Jim) Rogers Agricultural Index, which itself is a blend of a whole slew of soft commodities in various weights. You can get more information from its prospectus. The important item to note on RJA is that it is basically a promissory note, not an ETF, and does not hold any actual commodities or contracts. It is a liability of the bank or organization that sponsors it. In light of the financial crisis, this is an important consideration. Also, while RJA promises exposure to a wide range of commodities, the weighting may dampen any price run-up. For instance, when rice made its huge run, RJA barely moved as rice was less than 5% of the index at the time.

DBA is an actual ETF that is basically equal-weighted in four commodities: wheat, corn, soybeans and sugar. Obviously, this leaves investors out in the cold if rice or orange juice makes a big run but conversely, sugar is on a tear and the 25% (actually 31% according to ETFConnect) weighting gives investors better exposure to price moves. I would advise interested readers to read the prospectus to find out more about how the fund buys its contracts and how that might affect investor returns.

My inclination at this point would be to play the ag space via companies in the supply chain which can range from equipment suppliers like Caterpillar (CAT) to fertilizer producers like Mosaic (MOS) to seed companies like Monsanto. I feel more comfortable making buy/sell decisions on companies, where I can estimate intrinsic values, than with commodities where I have less of a base to judge fundamental value.

Keep in mind that each investor should determine the appropriate strategy for his own portfolio. What works for me may not be right for you and vice versa.

More on this topic (What's this?)
Mark Hansen: Bullish On Softs
Protected: A look at Agriculture
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Read more on ELEMENTS Rogers International Commodity – Agriculture Index ETN, Soft Commodities at Wikinvest

3 Responses to “Reader Question On Soft Commodities”

  1. Jay (market folly) Says:

    good points re: playing fertilizer or agribusiness companies versus the actual commodity etf’s. There is a lot of talk surrounding these commodity etf’s lately, in particular the oil ones. Bit of a hazy cloud of uncertainty right now if there will be regulations put in place since these vehicles are affecting commodity markets. If I had to pick one, I’d say DBA solely because it’s an actual ETF and you don’t bear any counterparty risk as you would with an ETN. But there’s just a lot of uncertainty surrounding these vehicles right now as to how they’ll be able to operate going forward.

    Jay
    @marketfolly

  2. Davy Bui Says:

    Please excuse my lag on responding to this — upgrading Wordpress after a hack-in but that’s done (yay!).

    I agree with you that it’s important for investors to understand the mechanics of how ETFs try to track their targets as they sometimes miss. I was looking at UNG for a little bit but the fund trades at a premium to NAV and it seems investors could get the general thesis right (nat gas will rebound) and still not make any money due to tracking error and fund mechanics.

  3. Sivaram Velauthapillai Says:

    I agree wtih Davy’s suggestion to look at businesses that may profit off a macro trend (this goes against Jim Rogers’ suggestion though.)

    The worst thing about commodities is the nature of the futures curve. You will lose a bit every time the ETFs roll over the commodity contract and if it is in contango. I haven’t looked at the softs to see how it is but the contango was horrible for oil and natgas in the last year or so.

    One just needs to plot USO, an ETF that tracks oil, to actual crude oil and see how much of a disaster that has been. Crude oil declined from a peak of around $147 to the present price around $68. In contrast, USO declined from a peak of around $115 to the present $35. So crude declined around 45% while the ETF declined 70%! Some of this is due to management fees/ETF expense/etc but those are minor costs compared to the loss.

    Of course, the futures curve can also work in your favour if it was the other way around (backwardation.) But it’s an additional element one needs to consider.

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