As some observers warn of a prolonged bearish outlook for the commodities space, with notable weakness in the energy market, investors can hedge against the potential risks with inverse exchange traded funds.
According to Morgan Stanley Investment Management Inc., the commodity bear market could last for many years, with oil prices dropping as low as $35 per barrel, reports Rakteem Katakey for Bloomberg.
Weighing on commodity prices, China, the second largest economy in the world and biggest consumer of raw materials, has experienced an industrial slowdown, which diminished demand growth.
“China continues to be the central player as far as demand is concerned,” Ruchir Sharma, Head of Emerging Markets at Morgan Stanley Investment Management, told Bloomberg. “Even if the Chinese economy stabilizes, the industrial part of the economy is likely to be much weaker.”
Meanwhile, depreciating foreign currencies, like the Russian ruble, and a stronger U.S. dollar have helped shield foreign producers from lower prices, which has deterred some oil drillers from cutting output, according to Sharma.
“A long winter in commodities is what we have to be prepared for,” Sharma added. “From places like Russia to Australia the currencies have fallen a lot and so the marginal cost of production for some of these commodities in those countries hasn’t fallen that much.”
Consequently, investors who fear additional pressure in the commodities space as the U.S. dollar continues to strengthen, especially while the Federal Reserve cogitates on an interest rate hike, can hedge against further weakness through bearish or inverse ETF options. For instance, ETF investors can hedge against falling commodities with broad options, like the DB Commodity Short ETN (NYSEArca: DDP), which takes the simple short position on a group of diversified commodities, and the DB Commodity Double Short ETN (NYSEArca: DEE), which takes the two times the inverse position on a basket of commodities. Additionally, the ProShares UltraShort Bloomberg Commodity (NYSEArca: CMD) also takes the daily -2x or -200% performance of the Bloomberg Commodity Index. [If Fed Hikes Rates, These ETFs Could Help Reduce The Backlash]
These broad commodity exchange traded products include heavy tilts toward energy-related futures. For instance, CMD’s underlying index includes 9.3% crude oil futures, 8.6% Brent oil futures, 8.4% natural gas futures, 5.2% unlead gas RBOB futures and 4.2% heating oil futures.
Additionally, for targeted exposure to oil, investors can utilize a number of inverse or bearish ETF options to hedge against declining energy prices. For instance, the United States Short Oil (NYSEArca: DNO) tracks the opposite moves of the West Texas Intermediate crude oil futures, and the DB Crude Oil Short ETN (NYSEArca: SZO) also tracks the simple inverse of oil. [Leveraged ETFs Are Popular Plays Among Swing Traders]
For the more aggressive trader, there are number of leveraged options, including the ProShares UltraShort Bloomberg Crude Oil (NYSEArca: SCO), which tries to reflect the two times inverse or -200% daily performance of WTI crude oil, and DB Crude Oil Double Short ETN (NYSEArca: DTO), which also follows a -200% performance of oil, jumped 17.4%. Lastly, the VelocityShares 3x Inverse Crude (NYSEArca: DWTI) takes the three times inverse or -300% performance of crude oil. [ETFs to Hedge Against a Grim Oil Outlook]
For more information on the commodities market, visit our commodity ETFs category.
Max Chen contributed to this article.