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Copper ETFs Try to Get Physical

By Benjamin Shepherd on September 26, 2012

Gold is still in the midst of its historic bull market, and SPDR Gold Trust (NYSE: GLD) has enabled the retail investor to take advantage of the yellow metal’s ascent. Since its late-2004 inception, the exchange-traded fund (ETF) has returned 277.7 percent, one of the best performances over that period in the ETF arena. But the fund hasn’t just been a success in terms of price performance. With $75.2 billion in assets under management, it’s also been a huge moneymaker for its sponsor, even with its low 0.40 percent annual expense ratio.

That, in turn, has attracted numerous competitors, including iShares and ETF Securities, which have launched similar funds backed by physical gold, silver and palladium. In fact, ETF Securities has even created a whole raft of ETFs backed by individual base metals that trade in exchanges overseas.

But in the US, it looks like the physically backed ETF movement might have gone a step too far.

Over a year ago, JPMorgan Chase (NYSE: JPM) filed a request with the Securities and Exchange Commission (SEC) for permission to launch a physically backed copper exchange-traded product (ETP). That idea was met by an immediate wave of criticism from end users, such as manufacturers of copper wire and copper merchant companies, which argued that such a fund would seriously deplete the global supply of a critical industrial metal. They feared the resulting shortage would drive global copper prices to unaffordable levels.

Even Sen. Carl Levin (D-Mich.) weighed in on the matter when he wrote to the SEC and urged it not to grant approval for the product. Levin expressed worry that such a fund would drive a “boom and bust” cycle in copper prices.

That concern is pretty understandable.

In addition to the fund proposed by JPMorgan Chase, BlackRock (NYSE: BLK) has also said that it would like to launch its own physically backed copper product. Between these two products, it’s estimated that almost 200,000 tons of copper would be taken out of the market almost immediately, with more to follow if the funds attract significant assets.

Since copper trades relatively cheaply in the US, most of the physical metal required to back such ETPs would likely be purchased and stored domestically. As a result, the US copper market could face a serious price spike if these copper funds were ever launched. That would create the perverse scenario in which the actual end users of copper must suffer the depredations of speculators who have no interest in ever taking delivery of the commodity they’re trading.

One way for JPMorgan Chase and BlackRock to allay these concerns would be to agree to spread out their copper purchases around the world. With more than 20 million metric tons of copper mined and refined around the world last year, the global copper market could probably absorb the loss of 200,000 tons to speculative investment vehicles. But so far, the pair seems reluctant to make this concession.

Although neither has made any public statement as to why that’s not an attractive option, it most likely comes down to pricing. While gold trades in a truly global market that keeps local spot prices relatively aligned, copper trades on a more regional basis. The price of copper can vary widely between markets based on local availability of supply and the corresponding demand, as well as the cost of shipment.

So if a sponsor of a copper-backed fund were to operate on a truly global basis, the share price of the fund wouldn’t accurately reflect the price of the commodity in any single market. And the difficulty in constructing such a portfolio would make the funds more expensive for their sponsors to operate. The resulting expenses would be passed along to investors, which could crimp demand for these products.

Additionally, copper-backed funds don’t enjoy the same imprimatur of industry trade groups that helped lead to the creation of gold-backed funds. In fact, physically-backed gold funds were largely the brainchild of the World Gold Council, a trade group that primarily represents the gold mining industry. By contrast, copper industry trade groups have spoken out against the creation of copper ETPs.

Given all these hurdles, US investors will likely have to content themselves with the slate of physically backed ETPs that already trade.

What’s New

There were no notable ETF launches last week.

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