Posted on 09/09/2011
Everyone is well aware of the effects of Hurricane Irene, especially those without power for several days afterwards. But there is another weather issue worth being aware of, if you are not already, and that is the drought in Texas (and Louisiana, Oklahoma, and New Mexico). A recent Time news article highlighted the devastation that is being wreaked upon these states due to the unrelenting heatwave and lack of rain. Triple-digit temperatures have become commonplace, as has a cloudless sky. This has resulted in loss of crops, the unfortunate need to sell off cattle, even the valuable breeding stock, and the inability to get new crops in the ground, such as winter wheat. All this spells the potential for disruption in supply of certain commodities. For example, Cotton is one crop that could directly feel the impact of the drought. Let's first take a look at a few facts about Cotton:
You may recall that Cotton was the darling of the commodity markets for roughly seven months, starting about a year ago and continuing until March. During this time, we saw Cotton go parabolic in its rise to new all-time highs, gaining roughly +145% during this period. Cotton was more than cut in half, falling from a peak of 226 down to a low of 96 by late July. Over the course of the past several weeks, we have once again seen a spike in Cotton price. After finding a bottom in late-July, the commodity has gained about 16%. You can follow the steps in the image below to search through AllETF for Cotton Exposure.
Today we wanted to focus specifcally on two of the funds in the table above, the iPath DJ-UBS Cotton Total Return Sub-Index ETN (BAL) and the iPath Pure Beta Cotton ETN (CTNN). On April 21st, 2011 Barclays launched their series of "Pure Beta" iPath Commodity products, which includes the CTNN, and are designed to provide similar exposure to commodity markets as their pre-existing commodity inventory, but while also offering a structure that can mitigate the impact of negative rolling yields within the commodity futures market (i.e. contango). There are of course both pro's and con's in using the futures market with which to structure a commodity index. Among the pro's would be general liquidity and the ability to own exposure to an asset without taking physical delivery of that asset. Neither of those benefits should be understated as many commodities don't store particularly well by conventional means, and the intuitive "markets" we might otherwise turn to aren't particularly efficient. 42-gallon drums of Oil don't fit nicely in a safety deposit box or basement, and the local Wawa is far more comfortable providing an "ask" for a gallon of Gasoline than a "bid" on a barrel of Oil. However, there are nuances regarding the futures market that can fall into the "con's" column as well, the impact of contango within futures structure at times is chief among them.
What was once viewed more as a subtle idiosyncrasy of the commodity futures market became far more mainstream over the past year when Bloomberg BusinessWeek ran with a cover story, "Amber Waves of Pain," explaining how negative rolling yields in the commodity markets (read: contango) have impacted the performance of many commodity-based funds. In short, contango is a concept that should be well entrenched within your ETF vocabulary. The new Pure Beta ETN products within the iPath family (such as CTNN) have primary difference with regard to existing iPath commodity funds (such as the BAL), which is the attention given toward mitigating negative rolling yields caused by contango within the term structure of a futures market. Currently, cotton is in backwardation, so the contango issue is somewhat of a moot point and both ETFs provide a way to gain exposure to this demand-driven commodity. However, this has not always been the case. For instance, if we look at the performance of these two ETN's going back over different time periods (provided below), we are able to see how an investment in the Pure Beta strategy has pulled ahead of the BAL. That said, the iPath Pure Beta line-up is a suite of funds to consider for those investors looking for ways to gain single commodity exposure.