Accessing the Electric Vehicle growth story via commodity ETPs
It’s fair to say that changes in the automotive industry, driven by a mixture of vehicle emission regulation and rapid advancement in battery technologies, have piqued investors interest over the last few years. Companies at the forefront of the evolution in Electric Vehicles (EV) have experienced rapid growth, and existing auto-manufacturers are scrambling to keep up.
Figure 1: Estimated global Electric Vehicles sales
Source: InsideEVs, January 2017 to January 2019.
However, increases in EV adoption aren’t just affecting the share price of certain auto companies. Looking beyond equities, we see potential in the individual commodities that are key components of the battery technology driving the industry forward.
Looking beyond equities
Exchange traded products (ETPs) have made commodities more widely accessible to investors through the provision of futures strategies in a share traded format. Most non-precious metal commodities cannot be traded physically because they are difficult and expensive to store. For example, agriculture and livestock are perishable and oil is explosive.
Therefore, investors seeking commodity exposure, without wanting to manage the physical asset itself, have turned to futures contracts. ETPs are no different. All ETPs aim to track an underlying index or asset, and Commodity ETPs make use of futures-based indices to gain commodity exposure.
Figure. 2 Battery technology metals & ETPs
There are several industrial metals poised to be affected by the global rise of electric vehicles and battery technology. But some – such as Cobalt and Lithium – have illiquid futures markets, and very concentrated supply chains which means ETPs cannot currently exist for these metals.
These issues do not apply to other metals, like Nickel and Copper, which means ETPs tracking futures-based indices are available to trade on exchange – just like stocks.
However, there are certain costs and benefits inherent in a futures exposure that investors should be aware of. Let’s take Nickel as an example.
By holding Nickel futures, investors would be exposed to three return components, referred to collectively as the total return. Since Nickel ETPs track total return futures indices, the return of these products will be composed of three elements:
- Spot Return: the movement of the underlying Nickel futures contracts.
- Roll return: All futures have an expiry and delivery date. So, to achieve a constant exposure, futures positions within the index need to be periodically closed out before expiry and transferred to a new longer dated contract. This process is known as “rolling” and can generate a “roll return”. This rolling process can result in a loss or profit to the investor. An investor will incur a loss where it costs more to buy the new futures contract than the amount received by selling the old futures contract (‘contango’). An investor will incur a profit where it costs less to buy the new futures contract than the amount received by selling the old futures contract (‘backwardation’).
- Collateral yield: the repayment of the cost of carry embedded in a futures contract. With a futures contract, most of the cash due to be paid on delivery of a commodity does not change hands immediately. In contrast, futures indices presume that the entire contract value is paid up-front. However, this would mean a futures index investor would lose the interest on cash that could have been earned by using futures contracts. As such, the index calculation includes a collateral yield to more accurately simulate a rolling futures exposure.
The graph and table below show a breakdown of these three elements within the Bloomberg Nickel Subindex from January 2018 to March 2019. This helps highlight the importance of investors being aware of the potential impact of contango and backwardation in commodity markets.
Figures 3a and 3b: Bloomberg Nickel Subindex Total Return
Source: Bloomberg, WisdomTree, January 2018 - April 2019. You cannot invest directly in an index.
Historical performance is not an indication of future performance and any investments may go down in value.
As discussed previously in our Technological Evolution series on battery technology, we believe that a combination of strong fundamentals and the increase in EV adoption could favourably impact the demand for commodities such as nickel and copper. You can access the previous instalments on this blog series, which provide a deep dive into current battery technology trends and factors driving adoption of Electric Vehicles through the links below.