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FP Answers: What should I look for when analyzing mining sector ETFs?

FP Answers: What should I look for when analyzing mining sector ETFs?

First determine how you want to access the sector since it can be done in several ways using ETFs

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By Julie Cazzin with Andrew Dobson

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Q: Given the demand growth that is widely anticipated for battery minerals, I would like to invest some money in an exchange-traded fund (ETF) that invests in the mining sector, especially copper as we also ramp-up charging networks. What should I look for when I am evaluating a mining ETF, and what are two or three mining ETFs that would be available to me as a DIY investor in Canada? — Tom

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FP Answers: Buying ETFs can be one of the simplest investing methods because there are plenty of low-cost, diversified funds available. Fund companies continue to release new and innovative products that provide exposure to the direction of stocks (including short ETFs that rise when markets fall), interest rates, commodity prices, currencies and other unique solutions.

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Commodity ETFs have been listed on Canadian securities exchanges for more than 10 years, with iShares, which has offered gold and silver trusts in ETF form since 2009, being one of the first. Since then, providers such as Horizons ETFs Management Inc., Bank of Montreal, iShares and Vanguard Investments Canada Inc., to name the largest, have been offering commodity ETFs that allow investors to gain exposure to commodity prices.

This exposure can be to commodity stocks trading on Canadian and international exchanges, as well as directly or indirectly to the commodities themselves. If you are focusing specifically on the mining sector, you should first determine how you want to access the sector since it can be done in several ways using ETFs.

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Single-commodity ETFs could be a good option if you want to direct exposure to one commodity. As mentioned, there are gold and silver trusts on both the Toronto Stock Exchange and the NYSE Arca (the world’s leading ETF exchange) that usually track commodity spot prices by holding the physical commodity in trust. This can be more appealing than using derivatives such as futures and/or options contracts to gain exposure.

In the case of ETFs that are listed in Canada and the United States that have similar underlying assets, you should consider foreign exchange rates, taxation and the overall cost when assessing which ones to buy. A Canadian ETF may also have U.S. estate tax filing requirements upon death if the person owns U.S. ETFs in a taxable account.

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In the case of copper, only recently has there been an ETF listed in Canada that offers indirect exposure via copper mining stocks. That is the Horizons Copper Producers Index ETF, which was released in 2022 and uses a highly concentrated portfolio of about a dozen publicly listed companies.

An option such as this may work if you are looking for exposure to the industry generally, but I would caution that exposure to miners/producers is not the same thing as holding the commodity. In theory, a well-run copper miner, with leverage, should be able to outperform the commodity itself, but that may not happen in practice.

There aren’t any other options available on Canadian exchanges that provide similar copper exposure as the Horizons’ ETF. There are, however, several ETFs listed in the U.S., such as the Global X Copper Miners ETF, Barclays iPath Bloomberg Copper Subindex ETF and USCF United States Copper Index Fund, that can be purchased in Canadian brokerage accounts. For example, the Global X fund is structurally similar to the Horizons ETF, but has more global exposure and less concentration among the largest holdings.

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The funds offered by Barclays PLC and United States Commodity Funds LLC (USCF) offer exposure to copper using futures contracts. These funds look to provide the return of copper’s daily price less any associated fees. Keep in mind that these securities are listed on U.S. exchanges and are considered U.S. situs assets — meaning they are located in or have a connection to the U.S. — so there could be tax and estate implications in a taxable account.

Also, keep in mind that because these funds invest in futures contracts, there are risk factors to consider, specifically the concept of roll yield, which refers to the return that an investor receives when they “roll over” an expiring futures contract to the next closest month contract for the same commodity. Because commodities trade via contracts that expire on monthly intervals, it can be challenging to maintain an investment that tracks the spot price of a commodity perfectly. It is an imperfect science.

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For example, copper contracts listed on the Chicago Mercantile Exchange (CME) typically expire on the last Friday of each month. If someone holds a futures contract long on expiry, they can choose to accept delivery of the commodity if they are in the money (meaning the contract price relative to cost is profitable), sell the contract prior to expiry for a profit or roll over the contract into the next month’s contract.

This concept of rolling over the position is most common when a mismatch of pricing between a managed product (that is, an ETF) and the spot price occurs. Generally speaking, this is less of an issue when commodities trade in contango (the futures price is higher than actual spot price).

Investing in futures-based ETFs may be the most effective way to gain exposure in terms of ease of access, but you should consider how a fund tracks the price of the commodity and delivers on that strategy.

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Commodities such as copper are traded via futures contracts that typically trade on commodity exchanges such as the Montreal Exchange, CME and NYMEX in New York City. Most of these cater to institutional investors because investing directly in futures can require investor accreditation, high minimum funding and maintenance amounts, as well as an advanced understanding of these financial instruments.

This is why the options are limited in this sector, though there are a few ETFs that should be able to meet your needs, Tom.

Andrew Dobson is a fee-only, advice-only certified financial planner (CFP) and chartered investment manager (CIM) at Objective Financial Partners Inc. in London, Ont. He does not sell any financial products whatsoever. He can be reached at [email protected].

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