CFTC Could Remove or Limit Commodity ETFs – Exchange-Traded Funds

Commodity ETFs exploded during the 2007-2008 boom year for virtually every commodity. However, as the Federal government continues to poke its nose around the financial markets, its taking a hard look at exchange-traded funds. The CFTC contends that it is exchange-traded funds that are causing manipulation on the commodities markets.

Commodity ETFs Causing Short-Term Turbulence

Commodity exchange-traded funds, such as the United States Oil Fund (USO) or the United States Natural Gas (UNG) buy futures on the commodity exchange to back up each dollar invested in the fund. For larger funds such as USO, and now UNG, the large transactions that take place are creating short term shockwaves on the commodities exchanges. For instance, both the USO and UNG invest in the front month contract, that is, the futures date that is currently the closest to expiration. Each month, the money invested must be shifted, from the expiring futures to the new futures, all of which takes place in a few short days.

Front-Running, How and Why It’s Done

Transparency, for ETFs, is both a benefit and a drawdown. Regulation requires that exchange-traded funds release their holdings at the close of trading each business day. This lets shareholder know exactly what they’re holding but also tips off front-runners in cashing in on the exchange-traded fund’s trading schedule.

Front-running Commodity ETFs

In the case of USO, it must buy the next month’s contract as soon as its current holdings expire. So let’s figure that on the 30th of each month, the balance of the exchange-traded fund is rolled over. USO, currently worth $3 billion, is no small fund, so when it trades, it moves markets. We figure that the price of oil has declined, however, the amount of money in USO has increased, so more oil will be purchased, even more than is already owned. Knowing this, we buy in a day before the United States Oil Fund rolls over, and when it does, we sell into the higher volume. Its like a pump and dump scheme you don’t even have to orchestrate.

What Can the CTFC Do About It

A lot. At present, the CTFC either wants to:

A: Ban commodity ETFs
B: Limit their size and scope

Banning commodity ETFs seems like an extreme, but its doubtful that such a vicious powergrab would take place. Limiting commodity ETFs seems much more plausible, as the SEC has already been horribly slow in expanding the number of shares that United States Natural Gas Fund (UNG) has on the market. The fund is one that has caused the most controversy, as its assets have exploded 500% in less than four months. It now controls a vast amount of natural gas currently trading, and wants to grow the number of shares in circulation by a figure of 10.

CTFC Debating the Issue

For the next month, the CTFC will be debating the existence and size of commodity ETFs with key figures and businesses in the exchange-traded fund business. After several public hearings, a decision will be reached, and it will be made public the future of the commodity ETF business. My guess is that exchange-traded funds are forced to change from monthly rollovers to a fund made up 12 future months, equal weighted in the portfolio.