ALWAYS GOOD TO DIVERSIFY

ETFs make it easy for retail investors to add a non-correlated asset class

The term “pure play” gets thrown around frequently in the resource space, but investors looking for this sort of exposure won’t find it unless they have direct commodity holdings. Outside of stashing gold bars under your bed or barrels of crude oil in your garage, commodity exchange-traded funds are the best way to go.

In general, investors have to take into account a number of factors when assessing a commodity. For example, with oil they’ll consider what Saudi Arabia is doing or what technical indicators are suggesting. The most natural option to express this view sends them to the stock market, where they’ll pick their favourite oil producer. “That’s a very dirty way to get crude oil exposure,” says Tim Pickering, president and chief investment officer of Auspice Capital Advisors.

For one thing, that energy company may have financial troubles in the form of high debt, lack of cash flow, few drilling prospects or bad management. Of course, it may be strong in all of those respects, but therein lies the important point investors need to consider: What are they looking for? Commodity-based funds provide investors — both retail and institutional — that pure play, thereby eliminating many of the risks brought by surprises from companies.

Another thing to be wary of is the market beta that commodity stocks bring with them. It’s no secret that moves in the broader market impact equities that don’t have a direct link to what’s going on at the macro level. There is no avoiding that. But when it comes to a commodity-based ETF, such as the Canadian Crude Oil Index ETF, United States Oil Fund ETF or those based on a wide range of other commodities such as gold, there is only one thing that moves the security: the price of the commodity.

Finally, commodity ETFs offer investors much-needed diversification when traded in a tactical and disciplined manner. “You’re really just looking for non-correlation among asset classes,” Pickering says. “By separating commodities from resource equities, you’re making an effort toward doing that.”