The Latest Way Onto the Commodity Bandwagon

For investors looking for blockbuster returns, the stock market has been a little disappointing in recent months. Increasingly, investors are looking to commodities as the next bastion of outsized gains, and Wall Street is happy to provide those investors with the vehicles they want to get the exposure they're looking for.

Why commodities now
If you're a long-term investor, you may have trouble understanding what draws people into a market such as commodities. After all, commodities represent physical things, things that in most cases can't grow or multiply into more of that given thing over time. To investors used to earning interest on deposits or dividends on equity investments, the idea of hoarding goods in the hopes that prices will rise doesn't necessarily seem all that appealing.

But for momentum-seeking traders, commodities are where all the action is. Just as stock investors have loaded into energy ETFs ProShares Ultra Oil & Gas (NYSE: DIG  ) and Direxion Daily Energy Bull 3x (NYSE: ERX  ) in the hopes of capitalizing on higher oil prices, so too have some looked for ways to benefit directly from rising prices of other commodities. Although vehicles in the precious metals investments arena, such as Central Fund of Canada (AMEX: CEF  ) and Sprott Physical Gold Trust (NYSE: PHYS  ) , are commonplace, other parts of the commodities universe haven't historically given investors as many options.

A new answer
That's the reasoning behind Barclays' (NYSE: BCS  ) decision to expand its iPath line of exchange-traded notes to include 18 new commodities-related ETNs. In addition to investment vehicles targeting broad commodity exposure, the new iPath ETNs include some very specific niche areas, such as livestock, cotton, and aluminum.

But Barclays isn't counting just on the novelty of its target niches to attract attention. Rather, it's hoping to correct a problem that some of the exchange-traded commodities vehicles that came before it have had.

In particular, many commodity-oriented ETFs have had problems relating to their use of futures contracts. Because using futures is far easier than taking delivery of actual physical goods, ETFs in most areas favor holding futures contracts. But using futures raises the question of which month's contracts you use. Funds such as United States Natural Gas Fund (NYSE: UNG  ) and United States Oil Fund (NYSE: USO  ) that use front-month contracts give the most direct exposure to changing prices, but they have also had long-term tracking problems that stem from the fact that the future-month contracts these ETFs have to trade into every month tend to have higher prices than the current-month contracts they're forced to trade out of. Over time, that has led to huge price declines for the United States Natural Gas ETF that far exceed the nominal drop in natural gas prices.

The iPath ETNs seek to remedy that situation by using indexes that have flexibility in choosing which futures contracts to use. With its Pure Beta methodology, the index manager can avoid price distortions to track true price movements more directly.

What to look for
If the new methodology proves to avoid some of the problems with contango and other futures-related phenomena that have hurt other commodity ETFs, then the new iPath ETNs could easily become the preferred way to trade in a broad range of markets. Already, one of its long-traded ETNs has more than $3.4 billion under management.

But ETNs have their own risks. Rather than holding actual assets, exchange-traded notes are debt obligations of the issuer. So if Barclays goes bankrupt, ETN holders could have trouble collecting even if the underlying commodity indexes have gone up. That's a problem that Lehman investors ran into during the financial crisis. And with annual fees of 0.75%, the ETNs aren't the cheapest exchange-traded vehicles on the block.

Perhaps most importantly, the question remains whether the bull run in commodities is getting long in the tooth. Unfortunately, many trends seem to top out just as a particular investment is getting popular. So if you're bullish on commodities, give these ETNs a look -- but also be on your guard for changing market conditions.

ETFs can help you find the way to better investing results. To find some great ETF investing ideas, take a look at The Motley Fool's special free report, "3 ETFs Set to Soar During the Recovery."

Fool contributor Dan Caplinger always wanted to ride on a real bandwagon. He doesn't own shares of the companies mentioned in this article. The Fool owns shares of Sprott Physical Gold Trust. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy cracks a mean buggy whip.


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