Nuclear related shares are getting pounded now as politicians and activist groups are calling for a significantly geared down approach to nuclear approach now.  So who wins?  Think solar.  Solar power plants melting down only causes black goo on the ground.  Coal… who cares if it is dirty at this point compared to nuclear fallout.  Wind and other alternative energy… Same for solar.  Natural gas is back… Many power plants run on this, and if nuclear power gets curbed too much ahead then natural gas is going to benefit just like coal does.  Here are eight ETFs that are trading higher as a direct result of the Japan quake knocking out the nuclear sector.  Oh year, a “Short Japan Fund”…

Market Vectors Coal ETF (NYSE: KOL) is up 1.75% at $47.01 against a 52-week range of $28.35 to $49.80.

Guggenheim Solar (NYSE: TAN) is up 6.3% at $7.83 against a 52-week trading range of $6.02 to $9.34. There is also the  Market Vectors Solar Energy ETF (NYSE: KWT) up 7.1% at $12.39 against a 52-week trading range of $9.04 to $14.33. PowerShares WilderHill Clean Energy (NYSE: PBW) is up 0.9% at $10.00 against a 52-week range of $4.00 (low from Flash Crash) to $11.42.

ProShares UltraShort MSCI Japan (NYSE: EWV) is up a whopping 15.6% at $39.30 against a 52-week range of $29.83 to $52.78… This one is 200% the inverse of the daily performance of the MSCI Japan Index.

United States Natural Gas (NYSE: UNG) is now up only 0.25% at $10.42 but this one was up as high as $10.78 earlier today.  The iPath DJ-UBS Natural Gas TR Sub-Index ETN (NYSE: GAZ) is also now ‘only’ up 0.57% at $7.09 but it was up as high as $7.31 earlier today.  Finally, the Teucrium Natural Gas ETV (NYSE: NAGS) is still up 3.1% at $22.97 but this one has extremely thin trading volume. 

Japan is one of those situations that is unfolding as a tragedy and it will have an impact on GDP ahead.  These are just the financial winners in exchange-traded products as far as what the stock market vote is today.

JON C. OGG

It turns out that the PowerShares DB Oil Fund (NYSE: DBO) traded about 0.3% higher than its actual value in crude futures late last week, and limits to shares could exaggerate premiums and discounts.  And the PowerShares DB Crude Oil Double Long Exchange-Trade Note (NYSE: DXO) has also suspended issuing new shares. Barclays has also said that it would, at least temporarily, suspend new shares from being issued in its natural gas ETN called the iPath Dow Jones-AIG Natural Gas Subindex Total Return Exchange-Traded Notes (NYSE: GAZ).

Barclays also said that it would stop issuing new shares of the iShares S&P GSCI Commodity Index Trust (NYSE: GSG) once the outstanding amount reached 55.9 million shares. If our data is accurate on the latest count, that looks to stand at roughly 52 million shares.  This is a semi-diversified product that tracks about 24 different commodities in energy, agriculture, industrial metals, prcious metals and livestock.  It is energy dominant, but this was a much more diversified fund that decided to limit its size.  This one also has traded at a premium to its underlying value.

It is unlikely that either Goldman Sachs Group (NYSE: GS) nor Morgan Stanley (NYSE: MS) will get to escape with total exemptions on limits to the size of the markets despite the notion that these are two of the largest players in the commodities trading space.  In the past, it has not been uncommon for those traders who trade futures to suddenly have the NYMEX or other exchanges suddenly impose higher margin requirements just to trade or hold positions in futures in commodities.  The underlying theme there is that you might not be able to stop speculation, but you can drive up the costs of playing poker for the same results.

There is a key takeaway for investors to consider here.  The “GLD” or the SPDR Gold Shares (NYSE: GLD) is probably not going to be immune to this trend of limiting the size or scope of speculative investment limits in the commodities markets.   The market cap of the “GLD” is over $33 billion and that is effectively just about all in direct holdings of gold bullion.  Should an ETF product have more gold than all but a handful of the world’s largest central banks?  Our belief is that this will be next on the list after the CFTC and regulatory bodies get limits on these energy contracts.

Ditto for the iShares Silver Trust (NYSE: SLV) with about $3.9 billion in assets and the iPath DJ AIG Copper TR Sub-Idx ETN (NYSE: JJC). These are not as much of leaders as some of the other ETF or ETN products out there, but the rules will probably be extended out to these next year.  Could you imagine the disparity between inflation of commodities if you had a market where speculation size limits were imposed in the energy markets but not in the prices of metals and other hard commodities?  Many of the soft commodities have had size limits imposed for years because of the size of the overall markets.

Many of these key ETF and ETN products are already starting to resemble closed-ends funds.  While the financial stocks are not at all related to size limits of commodity ETF or ETN products, many leveraged an inverse stock ETF products have been under regulatory pressure.  Look at what Direxion said about its highly-leveraged financial ETFs called the Direxion Daily Financial Bull 3X Shares (NYSE: FAS) and Direxion Daily Financial Bear 3X Shares (NYSE: FAZ).  This fund management group has been ahead of the curve by saying that these should not be held for the long-term and showed how the underlying index performance differed from the spot performance of those ETFs.

What many will want to know is if tulip contracts will be issued soon, and more importantly if there are going to be size limits on those.  After all, that is the most classic case of speculators driving prices above and beyond the reality of a fair market rate in history.  All joking aside, the size limits to some of these products will be here for a while.  It is also unlikely, although not definite, that investors will get a wave of newer competing ETF and ETN products that can compete against those already in existence.  Any time you see an ETF or ETN that has a fixed number of shares that cannot grow and any time these have a  real premium or discount to the net asset value that is beyond just a few snapshots due to market volatility and an inability for all prices to react simultaneously, then you are talking about closed-end funds.

This trend is not likely to be referred to in the history books as the “blip of time in 2009 where commodity ETF’s were capped.”  Speculators will still get to speculate.  But the price of poker will be higher.  This might even sound so late-Twentieth century, but most investors might even have to go back into investing in the stocks of the companies that actually are the real market participants in each commodity.

JON C. OGG
August 24, 2009

iPath DJ AIG Natural Gas Total Return Sub-Index ETN (NYSE: GAZ) is one we do not cover as frequently because of its volume. It seeks the returns potentially available through an unleveraged investment in the futures contracts on physical commodities comprising the index plus the rate of interest that could be earned on cash collateral invested in specified T-Bills. The index includes the Henry Hub Natural Gas futures contract traded on the NYMEX.  iPath S&P GSCI Crude Oil Total Return Index ETN (NYSE: OIL) is another one we do not cover as much because of its volume. This ETN seeks returns that are potentially available through an unleveraged investment in the West Texas Intermediate crude oil futures contract plus the T-Bill rate of interest that could be earned on funds committed to the trading of the underlying contracts.

iPath DJ AIG Copper TR Sub-Index ETN (NYSE: JJC) is not in energy, but it invests primarily in copper contracts and instruments that hopefully mirror the price of copper.  But do you expect that if regulation goes into curbing energy prices that the same effort would not be applied to metals and other inflationary hard goods?

The SPDR Gold Shares (NYSE: GLD) actually buys and sells gold bullion.  It is so large that it holds more gold than many large nations hold in reserves.  We could cover grains and other hard and soft goods as well.  The list almost feels endless.

I recently noted that some ETFs and ETNs might be forced to either close or adjust their scope like a closed-end structure, and part of this could include changing to a closed-end fund status.  That could create inefficiencies, but it would still be better than investors having no access at all.  It seems unlikely that the regulators would systematically begin shutting down ETFs and ETNs, but we could easily see these forced to some sort of closed-end or size-limit structure.  This will seem like heresy to some and mother’s milk to others.

The CFTC noted that it is directed to “ensure the fair, open and efficient functioning of futures markets.”  CFTC Chairman Gary Gensler has asked his staff to present all available regulatory options to carry out the CFTC duties and said, “My firm belief is that we must aggressively use all existing authorities to ensure market integrity.” The result is a series of hearings during July and August that will include input from consumers, businesses and market participants to determine how the CFTC should use its existing authorities to accomplish its mission.

The first hearing will focus on whether federal speculative limits should be set by the CFTC to all commodities of finite supply, in particular energy commodities.  Yep, that is crude oil, heating oil, natural gas, gasoline and other energy products. This is said to also include a careful review of the appropriateness of exemptions from these limits for various types of market participants.  Do not expect this to stop there.

This is stated…… The Commodity Exchange Act states that the CFTC shall impose limits on trading and positions as necessary to eliminate, diminish or prevent the undue burdens on interstate commerce that may result from excessive speculation. The CFTC currently sets and ensures adherence to position limits with respect to certain agriculture products, but not for energy markets where futures exchanges set position limits and accountability levels.

If you think the ETF’s or ETN’s are immune, they are not… The Commission will be seeking views on applying position limits consistently across all markets and participants, including index traders and managers of Exchange Traded Funds (ETFs); whether such limits would enhance market integrity and efficiency; whether the CFTC needs additional authority to fully accomplish these goals; and, how the Commission should determine appropriate levels for each market.

At the end of the day, many people hate speculators.  Many speculators hate other speculators.  But doing away with speculators entirely would be a cardinal sin to the markets.  We won’t bother calling these free markets any longer, but this would represent a sin if the CFTC decided to take this one to the strongest degree. Fortunately, it seems unlikely that the strongest form of regulation would occur.

Last summer, oil was trading at ridiculous premiums.  The speculators said they had no part in the price.  It may take another half-decade before someone can prove in a quantified amount by how much speculators (and commodity pools and funds that held public retirement funds) added to the price of oil.  It is hard to quantify, but it was obvious as a heart attack that it was there.  In retrospect, it is even more obvious.

In early March, the stock market was in free-fall and the edge of the abyss was very close.  The economy was shut down, the debt markets were shut off to companies large and small, and there was enough panic in the public investors that selling was just the norm.  And the mood and outlook, we’ll just remind you about how firearm sales and buying of silver of gold was becoming common.  But that first week in March when the meltdown was coming, that was speculators throwing the money in with the bet that finally enough was enough.  There was government help to the capital structure of course, but that was money from hedge funds, millionaires, and the public looking at DJIA components and major S&P components finally buying up stocks at prices not seen in a decade or longer.  Call it what you will, but speculators saved the market then.

Again, change here looks more likely than ever.  Speculators are not evil in general.  Public pension funds from states, counties, and municipalities were investors in commodities through last year’s peak.  Eliminating them entirely doesn’t seem fair either.  But eliminating speculators in the entirety would be a move that goes above and beyond a normal market.

Jon C. Ogg
July 7, 2009