Are ETFs Distorting the Marketplace?

August 10th at 1:00pm by Tom Lydon

Exchange traded funds (ETFs) are cheap, easily accessible, transparent and provide access to a wide range of asset classes. However, one analyst opines that the popularity of commodity and emerging market ETFs may have diminished the overall diversification value. Is it true?

Scott Burns, director of ETF analysis for Morningstar, for MoneyShow believes that the billions of dollars being funneled into commodity ETFs may be tipping the markets, resulting in a supply and demand imbalance in the commodities. [July ETF Assets: Commodities Fall.]

Commodity proponents would point out the diversification benefits of commodities for an investors portfolio, but they would reference data that showed commodities in backwardation – a condition where future commodity prices are lower than in the near delivery months.

However, contango – the condition where long-term contracts are more expensive than near-term contracts – has been rather persistent in the last couple of years. Burns argues that by using ETFs, investors could have been exacerbating the contango.

Additionally, Burns notes that ETFs make up a large proportion of emerging market investments and investors are more likely to be swayed by sentiments in developed markets than anything that has to do with the fundamentals of the emerging market, as witnessed in 2008. [Emerging Market ETFs Back in Favor.]

Not everyone has agreed that ETFs distort the commodities marketplace. When futures-based ETFs were under regulatory examination last year, providers like United States Commodity Funds defended charges that their ETFs were leading to irregularities. During 2008′s run-up in oil prices, United States Oil Fund (NYSEArca: USO) was a seller of contracts and a buyer when prices were falling.

For more information on trading ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

Tickers

USO