Article Excerpts From: The Rewards of Multiple-Asset-Class Investing (pdf) From: An Introduction to the Dow Jones - AIG Commodity Index To help insure diversified commodity exposure, the DJ-AIGCI relies on several diversification rules. Among these rules are the following: * No related group of commodities (e.g., energy, precious metals, livestock and grains) may constitute more than 33% of the index as of the annual reweightings of the components. * No single commodity may constitute less than 2% or more than 15% of the index. From: Commodity ETF Overview -- Seeking Alpha, February 12, 2008 From: An Alternative To Taxes? -- Index Universe, May 23, 2007 Tax issues are becoming increasingly important as investors move into alternative assets, which don’t enjoy the same favorable treatment as regular stocks and bonds. My sense is that some people have been caught off-guard by the tax implications of their investments. Here is my cheat sheet: Futures-Based Commodity ETFs (DBC, GSG, USO, DBA, DBB, etc.): There is no deferral of gains with these ETFs. Period. All futures investments are “marked-to-market” at the end of the year. That means if you buy the US Oil Fund (USO) for $50/share and it closes on December 31 at $60/share, you owe taxes on that $10/share gain … even if you never sold the ETF. That’s right: you have to come up with the cash out-of-pocket. These gains are taxed 60% as long-term gains and 40% as short-term gains. From: The Best Ways to Protect Your Money -- Money Magazine, April 8, 2008 The best hedge: a natural-resources fund As for stocks, a traditional hedge against inflation has been natural resources. Reason: Fuels, minerals and agricultural goods have a certain amount of usefulness no matter what. You still need wheat to make bread, and your grocer will sell you a loaf if you slap down a gold coin. But since commodities don't throw off interest or dividends, their price on any given day is just a guesstimate of future supply and demand. And because they've shot up tremendously in short order (gold went from $800 an ounce in December to past $1,000 at one point in March), they carry substantial risks of their own. The stocks of companies that mine, farm and drill for these commodities haven't rocketed as quickly. That's one reason you're better off in a fund like T. Rowe Price New Era ( PRNEX ). This Money 70 stalwart invests in oil and natural-resources companies such as ExxonMobil (XOM, Fortune 500) and Schlumberger (SLB) - not in the commodities themselves. The fund has risks, of course. It has gained nearly 30% a year for five years; if oil prices fall and inflation subsides, you could lose money buying in at this level. So understand what you're getting with New Era: not a chance to win big but insurance against the risk that inflation will get worse. If peace of mind is worth it to you, shift about 5% of your stock portfolio from other large-caps to the fund. That's enough for insurance but not so much that you're betting your future on commodity stocks. From: Diversification with commodities? -- The Bogleheads Forum, May 28, 2008 Larry Swedroe wrote: ETNs Nice for tax purposes but I would not buy them because you are taking two considerable and uncompensated risks: a) Risk of tax treatment being disallowed, this is purely form over substance IMO. b) The credit risk of the issuer. Let's assume that the issuer pays say 0.5% over Treasuries for borrowings. You are taking that credit risk but not earning that extra return. Thus if an ETN costs you say 75bp it is really costing you 1.25%, only you just don't see the bill. From: Are ETNs Joining the list of Troubled Financial Products? -- Yahoo Finance, September 25, 2008 While much of the public's attention has been focused on exotic financial instruments like credit default swaps (CDS), collateralized debt obligations (CDOs), and auction rate securities (ARS), the $5 billion exchange-traded note (ETN) business has received little mainstream media attention. But the stunning collapse of major financial institutions like Lehman Brothers Holdings (Other OTC: LEHMQ.PK) could change that by heightening the scrutiny of these little known financial products called ETNs. [...] In a similar arrangement to investing in bonds, ETN payments rely on the full credit and faith of the institution backing the product. [...] Having portfolio exposure to hard to reach asset classes like commodities, currencies, or other specialized investment strategies is the typical ETN sales pitch. Another benefit is zero tracking error, which basically means obtaining identical performance to the underlying index or security. Under the current tax law, commodity and equity linked ETNs are taxed as prepaid contracts. This means investors incur tax consequences only upon the sale, redemption, or maturity of their note. However, this tax loophole is likely to disappear in the future. [...] For investors relying on the safety of credit ratings, think again. The financial strength of institutions like American International Group (NYSE: AIG - News) and Lehman Brothers deteriorated so fast and unexpectedly, not even the hallowed credit rating agencies could keep up. [...] Purposeful investing should be quick to reduce financial risks, but ETNs don't do that. Along with market risk, ETN investors also bear credit risk. As the Lehman ETN blowup illustrates, if the company backing the products goes out of business, ETN investors are left in the lurch. From: USO: Death by a Thousand Contangos -- Seeking Alpha, February 24, 2009 USO is not a long-term proxy for crude oil. Buy-and-hold investors who do not understand the structure of USO will underperform crude. [...] USO holds all its funds in next-month WTI futures. For example, USO started out February fully invested in the March WTI contract. Midway through February USO rolled all its funds into the April contract. [...] When oil is in contango, far months are more expensive than near months so USO’s rollover loses money. The loss is mitigated somewhat by the interest USO earns on its funds (only 10% of funds are needed to secure a contract). Also when oil is in backwardation the rollover makes money. However, over USO’s history, oil has been in contango more often than backwardation. Consequently, over its history, USO has lost value relative to oil. The ratio of one USO share to the price of crude was 1.0 when USO was launched. Today the ratio is 0.68. It’s essential to appreciate that this process has NO intrinsic lower limit: a prolonged period of contango can drive USO down indefinitely even while spot oil remains unchanged. Anyone considering a buy/hold strategy for USO today should be aware that oil has been in very steep contango and likely will remain thus for some months to come. This has been very costly to USO in recent months as a comparison of crude prices to USO readily shows.