ETF Talk: Into The Pits For A Splash

In auto racing, you often hear about a car coming in for a pit stop and taking a “splash.” For those of you who aren't acquainted with racing lingo, that just means the car is going to be filled with gasoline. Taking advantage of that splash often helps the team go the distance and finish out a race near the front of the pack.

Now investors may have their own chance to take a splash and finish in front of the pack, courtesy of a new exchange-traded fund (ETF) designed to take advantage of record-high gasoline prices.

This new ETF is the United States Gasoline Fund (UGA). The fund tracks the commodity price of gasoline. With gasoline prices hitting an inflation-adjusted record high on Monday, March 3, of $103.95, anyone who invests in this fund establishes a personal hedge against the rising gasoline prices at the pump.

The release of UGA comes amidst a boom in the value of commodity ETFs, a trend that I want you to approach with caution, especially if you are considering jumping into anything commodity related (more on this in the next section).

The rising volume in commodity ETF trading indicates to me that this commodity rally could be running out of fuel. If a correction comes, you do not want to have just bought into one of these funds, and you especially don't want to have bought into UGA at record levels.

The following table shows ETFs that track a single commodity -- such as oil, gold, silver, gold, and natural gas. These ETFs do not track the companies that produce, mine, or work with the given material. Rather, they just track the commodity itself.

The trading volumes in the above table generally are on the high end, since any ETF with a volume in excess of one million shares per day is considered heavily traded. These ETFs have a high level of penetration in the marketplace, and are owned by both institutional and individual investors.

Next week, we'll take a look at ETFs that are diversified into more than one commodity. Those ETFs also play the commodity boom but they consist of funds that spread their risk among multiple commodities, rather than take the “pure play” approach.

Still, I like the idea of being able to take a splash when the pedal is to the metal in the gasoline market, and I definitely recommend putting UGA on your watch list of commodity sector ETFs.

Are Commodities Overcooked?

Speaking of commodities, the great run in the sector has really helped savvy investors add to their profits in this tumultuous market environment. However, the fast-moving nature of commodities makes their direction not only difficult to predict, but also risky to own -- especially when these funds are making record highs.

Also, it seems that everywhere I look I see people pounding the table about the bull market in commodities. Certainly commodities have had a great run, as evidenced by the chart below of the PowerShares DB Agriculture (DBA).

This commodity ETF, which includes energy, metals and grains, is it up about 20% year-to-date. A very nice move indeed, but whenever a sector gets so hot so fast, I start looking toward opportunities on the other side of the trade.

I think what we have here in DBA is a case where access to a market via ETFs may have created a speculative bubble. Before commodity ETFs were around, the only way to invest in corn, wheat, oil and a number of other commodities was via the futures market. Most investors didn't want to fish in that complicated pond, but now, thanks to ETFs, it is extremely easy to buy and sell nearly every type of commodity.

Of course, most of the action lately has been on the buy side, but that massive buying also can quickly turn into a massive correction.

The bottom line here is that if you are considering jumping on the commodities train, do so with extreme caution. Always have a stop loss in place to limit your downside, and be prepared to see the value of ETFs such as DBA and others fall rapidly.