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SLCG Research: Futures-Based Commodity ETFs

SLCG released today a new study about Futures-Based Commodity ETFs. In the past decade the price of commodities has increased substantially and many investors have wanted to diversify their portfolios by including commodities. The most common way to invest in commodities is by buying futures contracts, which requires a good understanding of the pricing of futures contract and specific features of the futures market.

In the past few years we have seen many firms offer Commodity Exchange Traded Funds (ETFs) to facilitate in diversification through commodities. Some of these ETFs have grown exponentially, for example GLD, a gold ETF, has total assets of about $7 billion, and USO, an oil futures ETF, has total assets of more than $1 billion.

In this paper we explore the rising group of Commodity ETFs that hold futures contracts and rebalance their portfolios periodically when the contracts expire. The returns of these ETFs have deviated significantly from the changes in the prices of their underlying commodities. We use crude oil ETFs (USO, USL, DBO) as case study examples to examine the sources of the deviation. We find that this deviation is correlated over time and that a significant portion of this deviation can be predicated by the term structure of the crude oil futures market.

We conclude that even though Commodity ETFs provide an alternative avenue to diversify through commodities, only investors sophisticated enough to understand and actively monitor commodity futures market conditions shall consider these ETFs.