Abraham Bailin: Hi, I'm Abraham Bailin. I'm here with Sal Gilbertie, president and co-founder of Teucrium.
He has joined us today to speak about agricultural and energy specific commodity ETFs.
Sal, thanks for being here.
Sal Gilbertie: My pleasure.
Bailin: You guys have brought three funds to the market recently that looked to do very well, and they are slightly different than their predecessors.
But before we really get into the fund-specific discussion, might you just provide our viewers with a bit of insight into where you think the markets are now, what you think some of the underlying drivers are, and what really drove you guys to bring these various commodity-specific funds to market?
Gilbertie: Sure. Well, primarily we're a company composed of energy and agricultural commodity professionals, that's what we know. So stick to businesses you know, that's what Teucrium does.
We came to this space because of a true core belief that we have that commodities in the past five to 10 years have come into the mainstream through many of the academic studies and institutions have begun investing, and they are actually core portfolio holdings for many professional money managers, and they're just coming into the mainstream.
So we looked at the product slate that was out there, we thought we could make some improvements, obviously we have some products where there aren't any single-commodity ETFs in that commodity. We also brought out CORN, Teucrium Corn Fund was our flagship fund, and there was no corn ETF [prior to that].
We did that because we truly believe the next five to 10 years will bring commodities into everyone's portfolio. They will be in the mainstream. The rest of the world, the BRICs nations that are so in vogue, there's an emerging middle class coming, and essentially Americans have taught people how to use a lot of stuff. They use a lot of commodities, and so as this middle class outside of what we consider the industrialized world expands, those people are going to use a lot more of the world's resources, and quite frankly there's an infinite possibility for the number of humans that can populate the earth and there's a finite number of resources.
So we believe there will be stress on the global commodity picture and we want to be there to provide well-structured investment product for investors.
Bailin: So we got the demand-pull side of this story. Is there anything else in that story or really is it middle class growth?
Gilbertie: I think there's a lot in that story. It's global expansion. It's just as the economy grows, as we come out of the troubles that we've seen in the past two years, it's economic growth, it's just the expansion of humanity, it's middle class expansion, it's a number of factors.
Just consider automobiles: that China has become a number one importer of automobiles or purchaser of automobiles now in the world. They passed the United States. Automobiles use a tremendous amount of resources.
So commodities will be stressed; we're here to provide the product to investors so that they can participate as they see fit.
Bailin: Well, you had touched on it earlier. In CORN, you guys are the lone man, first ones to make it to market, and really with corn's performance recently, I think there is quite a bit of pent-up demand for that type of offering, but you guys also provide several other offerings. So for natural gas offering NAGS, and crude offering CRUD, and we have several well known exchange-traded vehicles already in place there, namely obviously UNG and USO in the natural gas and oil space, respectively.
As you had mentioned, there are a couple of downfalls to those products, and if you wouldn't mind without being too vicious, please, could you just speak about maybe the issues surrounding contango and negative roll yield and could you just touch on that for our viewers?Read Full Transcript
Gilbertie: Sure. There are many products out there, you've named two of them, that trade the front month or a single month of a commodity, and then roll it forward. When a futures contract expires, that has to be replaced, and there is a cost of carry that's involved, and this term "contango" that investors hear, it's really quite simple to understand: If you have a commodity or anything that you purchase, there is a cost of storage, of keeping it, of insurance you pay for it. So as time passes, that should rise in value, all else being equal. So the norm for a commodities market is contango, meaning the futures curve, the prices as you get out into the distance, appreciate with these costs as they build up, your storage costs.
Energies and agricultures have immense storage cost. An ounce of gold is an ounce of gold. It takes up very little space, and so it can be a physically backed ETF. There are very efficient storage economics there.
A bushel of corn weighs 56 pounds, and with 16 ounces in a pound, just do the multiplication. It takes up a lot more room. It's perishable. Corn lasts a couple of years if you store it in perfectly good conditions, but there are completely different issues of storing say metals and agriculture.
Bailin: Sure, and you have to cover the farmers opportunity cost.
Gilbertie: Correct. So what investors need to be aware of is this cost of carry, this contango, is an issue especially in energy and agricultural commodity. So the first generation of ETFs and indexes that came out, they generally buy one contract, concentrate their holdings and roll them. They are really…
Bailin: ...That was the front month contract?
Gilbertie: Correct, but they roll out before delivery. So, all of these are financially settled. They really are very liquid, and if you have a short-term view, those are fine products to use. But if you are going to go longer than a roll period--so in 30 days, say, for natural gas or crude oil, you might want to consider a fund, and there are many of them, not just Teucrium funds, that are structured to mitigate these effects of contango and backwardation.
Specifically Teucrium has designed all of our funds around each commodity. So corn for instance, we never hold spot month. We don't like the contango and backwardation issue. We try to mitigate it. Those effects are generally most intense in the front month, so we don't hold front month. We hold second and third month in corn, and the December following third month. December is a crop year contract. The liquidity pattern…
Bailin: So, you guys are targeting commodity-specific very pertinent contracts within each respective commodity industry?
Gilbertie: That's correct. Each commodity that we bring out and more are coming. They are designed specifically around the commodity. So our crude oil contract has June, December and December contracts in it, and they alternate between June and December. Natural gas has March, April, October and November, its four contract months, but when taken together and held for a period of time, they represent the 12 months as if you held the first 12 months.
Bailin: So you're getting couple of benefits there, right? So as opposed to rolling from the closest expiration futures contract to the next month out, not only are you avoiding the outsized effects of contango--that is to say, the prices of later contracts being more expensive further out in the curve--not only are you avoiding those effects on that front month roll, but also you guys are slicing your asset pool several times and participating in further-out contracts that won't be hit as hard by contango?
Gilbertie: That's correct. Simple math on contango, if you concentrate your holdings in one contract, say natural gas, it expires 12 times a year. Your portfolio turnover is 1,200% contango or backwardations can hurt or help you. Again contango isn't always bad, and backwardation isn't always good. Those are subjects we can get into in more detail, but we only roll our natural gas portfolio, you know, a quarter of it, four times a year, so we have 100% portfolio turnover.
So simple math, we help very dramatically mitigate the effects of contango and backwardation, but two other things help: One is we're product specific, so we design our commodity holdings, our benchmark holdings, around the futures contracts that are really chosen by the patterns, the seasonal patterns, the trading patterns by the people who trade them. So the professionals…
Bailin: So you are hitting the most liquid contracts here?
Gilbertie: ... Correct, but by nature they are the most liquid and they take into account the seasonality and other unique characteristics of each commodity, and that's how we design the product. So that helps mitigate contango and backwardation.
We also have a static benchmark. You hear a lot about portfolio optimization and optimizing the roll from some products that are out there, and they are very good products.
That said they get to chose every time they roll, so it's more of a dynamic choice. Teucrium is founded upon the principles of transparency and liquidity, so if you have calendar and look at our benchmark, you know what we're going to hold 10 years from now--it's very specific, and we believe investors want that transparency and liquidity in their products.
Bailin: As many of our viewers are aware of it, and as we've talked spoken about in private, there is a couple of very dynamic, broad commodity products that have come out, USCI being one of our favorites and DBC has now grown to be the largest broadly based commodity holding.
But just in terms of your investment thesis, you guys target very specific commodities. So, if you could, just speak about how best to use a single-commodity-specific product versus say a broadly diversified product that hits the broad commodity space.
Gilbertie: Sure. Well, if you want general commodity exposure, most likely for portfolio diversification, the beta side of your portfolio, you want commodities to move opposite stock market or your other core holdings, those are fine products. We think USCI is a particularly good product.
What happens is, if you want to increase your performance, so the alpha side of your portfolio, you actually want to make money rather than just be diversified, you're going to need to overweight or underweight commodities.
So again, if you have a short-term view, there are products out there that concentrate their holdings in a single month, they're very fine to use. If you have a longer-term view, a month to a year, say, a year and half, you might want to look at some other products, Teucrium products as well, to overweight or underweight those core benchmark holdings.
Bailin: So, using these strategies that Teucrium has implemented in its three offerings so far, you're able to, correct me if I'm wrong, but overweight a single commodity based on an investment thesis while having the ability to safely maintain that over a longer period.
Gilbertie: Absolutely. So you can buy your broad-based index. You don't have to worry about rolling short-term gains, long-term gains, and you can overweight/underweight when there is, for instance, a crop problem in corn like there was last year, you can use CORN to overweight.
Bailin: Well Sal, thanks for being here, a great discussion and really appreciate it.
Gilbertie: Thanks, Abe, pleasure.
Bailin: For Morningstar, I'm Abe Bailin.