Quick show of hands, who likes alternative investments?
Wow, that’s a lot of hands.
Then let me call your attention to Bloomberg’s Businessweek‘s recent article “Amber Waves of Pain.” Discussing commodity ETFs, it clearly outlines why these alternative investments lag behind their indices. The answer (among others) is a phenomenon known as Contango.
According to the article, Contango describes a market condition in which the contracts for future delivery of a commodity are pricier than the contracts for more immediate delivery. Why would that happen? Well, maybe it’s known that someone has to sell their current contracts and move the delivery date out. Someone like an ETF.
So the ETF takes your money and invests it in commodity contracts. Now these contracts expire after a few months, so our good friends at the ETF have to sell the expiring contracts and buy new ones. Why must they sell, if it’s such a bad deal, you ask? Because it’s either sell or take delivery, and I assure you the last thing an ETF needs to deal with are a whole bunch of rail cars of commodities. So now they’re stuck, and the other traders on the exchange can take advantage of the situation. And take advantage they will.
So where does that leave you, Mr. or Ms. Commodities-are-a-great-alternative-investment-to-increase-possible-returns-while-diversifying-your-portfolio? It leaves you holding the bag.
There’s more to the story, of course, so click on over to the full article if you have a few minutes to read. It’s a good one.