London, 12 March 2010

Following the news this week that both UBS and Deutsche Bank (DB) have launched ETC platforms, DB today launches new research on the European Exchange Trade Commodities Market: The Race for Assets in the European Commodity Exchange Traded Products Space.

The research highlights:

• Demand for commodity Exchange Traded Products (ETPs) is now just below 50% of the ETP market (as at 5 March 2010) which signals a shift in the market  due to an increased demand for gold and commodity like returns.

• Overall growth of Exchange Traded Commodities (ETCs) growth will slow this year from 145% growth in 2009, due largely to 2008 and 2009 representing the commodities space reaching critical mass, making further growth harder to achieve. Growth will remain healthy, estimate between 60%-90% in the European C-ETP space for 2010.

• Start of 2010 very busy, 43 new ETC products added in January and February (222 total at end of 2009) 
* Gold is slipping as most invested commodity - now at 57% of ETC market share from 67% in 2008 
* Commodity ETP investors turning to non precious metals

The Race for Assets in the European Commodity Exchange-Traded Products market

• As of March 5 2010, commodity exchange-traded products (C-ETPs) hosted €23.1 billion, split roughly 50/50 between exchange-traded commodities (ETCs) and exchange-traded funds (ETFs) tracking commodity indices. Historically, ETFs (mostly targeting precious metals and general commodity index returns) held the lion's share, but that is about to change, with ETCs (that target primarily single commodity returns) about to overtake them. This is a shift that signals a change in investor risk appetite in the year ahead. We believe that this is due to (a) decreasing demand for gold, and, (b) increased interest in specific commodity return profiles.

• The big winners (in terms of attracting assets) in 2010 will be industrial metals and indices tracking the broad market, while Swiss domiciled ETFs tracking gold will continue to grow. In terms of trading, Energy will remain a highly popular sub-sector, especially in light of a number of energy leveraged products being launched.

Continued AUM growth expected, in the region of 60%-80%, albeit slower than 2009 (145%), but higher turnover likely

• 2009 was an exceptional year and together with 2008, saw investment that proliferated commodities as an asset class in the ETP space. With the sector reaching a critical mass, marginal growth will be harder to achieve.

• Overall we expect the C-ETP sector to continue experiencing inflows. The growth of the C-ETP sector will likely slow in 2010 from the 145% observed in 2009, but will remain healthy. We estimate growth between 60%-90% in the European C-ETP space for 2010.

• Precious Metals flows likely to slow as these have now reached a fairly significant size of the industry. In addition, with the decrease of volatility in the equity markets, some gold flows are likely to be directed back to equity. The first two months of 2010 saw net outflows from UK based gold C-ETPs and net inflows for Swiss based gold C-ETPs.

• Despite slowing flows, the gold C-ETPs remain the biggest single commodity sub-segment, (57%), with Overall commodity indices well below in second place (13%) and Broad Agricultural Indices in 3rd place (5%). Given the current size of the precious metals sub-segment, it is likely that it will maintain its dominance in 2010.

Very busy C-ETP launch calendar in the first two months of 2010

• In anticipation and building on steady growth over the past couple of years, product launches in the first two months of 2010 were very strong, totaling 45 YTD 2010, compared with 66 for the entire 2009. Five existing providers came to market with new C-ETP products.

• Swiss managers launched 26 ETFs (primarily targeting long gold returns denominated in a number of currencies besides CHF) employing physical replication. EU providers launched ETC and ETN products targeting a wide range of non precious metals commodity benchmarks.

• Non precious metal commodities continue to attract investment but at a rate slower than 2009, gold inflows are regionally split

• 2009 saw net inflows in all six commodity sectors (Agriculture, Broad Indices, Energy, Industrial Metals, Livestock and Precious Metals), totalling €9.7 billion (average €800 million per month).

• Overall C-ETPs in 2010 YTD saw €631 million of net inflows for the first two months of 2010, with outflows of €32 million in Agriculture and €67 million in Energy, primarily driven from Brent Oil (€31 million) and WTI (€21million).

• 2010 YTD average monthly net inflows stand at €316 million, 25% lower the respective number for 2009, €425 million.

• Given the busy product launch calendar we expect inflows to pick up over the second and third quarter of 2010. As more long and short products become available on a number of the dominant C-ETP sectors (short precious metals, Oil, Agriculture), these products will increasingly find a home with institutional investors and active value traders looking for value as the year progresses.

Energy remains the most traded C-ETP sector, at 2.7 times that of overall C-ETPs

• Overall C-ETP average monthly AUM-normalized turnover (Turnover/AUM) in 2010 is at levels comparable to 2009, with agriculture and industrial metals showing slightly higher levels than their respective prior year.

• The highest AUM-normalized monthly turnover continues to be observed in the Energy (0.45) sector, remaining 2.7 times that of the overall C-ETP equivalent number (0.17)

• Turnover for non-precious metals C-ETPs will likely increase as more products become available and they continue gaining popularity with institutional investors and active traders. These are likely to become investment tools for traders hoping to benefit from changing economic trends.

C-ETP fee structure transparency is becoming an issue

• Deutsche estimate that the average cost of investing in a C-ETP ranges between 0.67% and 1.22%, a range that is higher from the average prospectus stated total expense ratio, which on average ranges between 0.51% and 0.67%. The difference is attributable to a number of other costs which result from enhancements to the C-ETP structures (for example collateral provision cost) as well as replication related fees such as swap spreads and index licensing fees. The cost of leveraged C-ETPs is on average 40 bps over their respective long cousins. These costs will likely drop as the market becomes more competitive and additional providers enhance their product ranges.

ETN issuer counterparty risk: an incentive for the use of these instruments by short term investors?

• ETN holders have direct counterparty risk to the issuer as ETNs rank pari-passu with the issuer’s other general senior unsecured debt. However, the ETNs’ pricing does not incorporate a credit spread for the investor taking on issuer counterparty risk. The ETN issuers will typically redeem these notes at the ETN’s target benchmark valuation but if redemptions are suspended and the secondary market is the only source of liquidity credit spreads will likely apply. The experience in the US suggests that these instruments have mostly been popular with short term holders, usually intraday, where counterparty risk is not a major issue. Therefore these are more likely to be trader’s instruments.

Return measurement: Excess or total return?

C-ETP investments are funded investments as the investor pays up-front 100% cash to obtain exposure; therefore total return (asset/future return +funding return) is the relevant return to use. Several providers in the market deduct the cost of providing collateral, which in the current market is close to the cost of funding, from total return, essentially transforming the C-ETP’s return into an ‘excess’ return. Collateralization makes structures safer and it is very desirable, and since direct spot exposure is largely unattainable for most commodities (with the exception of precious metals), a C-ETP structuring mechanism is necessary. A fine balance needs to be struck between collateral charges (payable by investors) and funding returns (receivable by investors). The economic fundamentals of the collateral’s underlying market play a big role in assessing this dynamic balance as they are likely to vary over time. These considerations are particularly important in a low interest rate environment, such as the current.

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