Looking For Lean Hog Rally Play? Try These ETFs

After a dismal performance in 2013, several commodities have been flying higher this year. While coffee, natural gas and sugar continued their ascent, reaching fresh highs, lean hog is not far behind the broad commodity rally.

In fact, lean hog futures turned out to be the best performing commodity after coffee in the Standard & Poor’s GSCI Spot Index, gaining 31% in the year-to-date time frame. The biggest reason for this surge is the porcine epidemic diarrhea (PED) virus that has spread to farms in 25 U.S. states and killed millions of young pigs, curtailing supply of pork.

The largest U.S. meat processor – Tyson Foods (TSN) – expects pork supplies to drop 2–4% this year. The U.S. Department of Agriculture last month reduced the pork production outlook by 0.7% and domestic pork supply by 0.6% for 2014. Further, most market experts estimate that the piglet virus will weigh more on pork supplies in the second and third quarters, in turn pushing up hog prices in the short-to-intermediate term.

Though direct hog play in the ETF form is not currently available in the market, investors seeking to ride out this bullish trend might look at the three livestock ETNs. Any of these could be an excellent choice given their decent Zacks ETF Rank of 3 or ‘Hold’ rating:  

iPath Dow Jones-UBS Livestock Subindex Total Return ETN (COW)

This note tracks the Dow Jones-UBS Livestock Subindex Total Return, which delivers returns through futures contracts on livestock commodities. The benchmark provides 62% exposure to live cattle and the reminder to lean hogs.

The product charges 75 bps in fees per year and has amassed $53 million in its asset base. It trades in average volume of under 19,000 shares a day, suggesting additional cost in the form of a wide bid/ask spread. The ETN has added nearly 14% year-to-date.

UBS ETRACS CMCI Livestock Total Return ETN (UBC)

This product follows the UBS Bloomberg CMCI Livestock Total Return, which seeks to deliver returns from a basket of futures contracts representing the livestock sector. The commodity futures contracts are diversified across two constant maturities of three months and six months.

In terms of holdings, a big chunk of the assets is tied to live cattle at 59% while lean hog takes the remainder in the basket. The product is less popular and illiquid with AUM of just $5 million and average daily volume of less than 15,000 shares. The ETN charges 65 bps in annual fees and has gained over 11.5% so far this month.

iPath Pure Beta Livestock ETN (LSTK)

This ETN seeks to match the performance of the Barclays Commodity Index Livestock Pure Beta Total Return. Unlike many commodity indexes, this benchmark can roll into one of a number of futures contracts with varying expiration dates, as selected, using the Barclays Pure Beta Series 2 Methodology.

Live cattle accounts for 60% of the assets while lean hog makes up for the rest. LSTK has attracted a small asset base of $2.7 million so far and trades in a paltry volume of less than 1,000 shares a day. As such, investors have to pay extra in the form of a wide bid/ask spread beyond the expense ratio of 0.75%. The ETN is up nearly 9% in the year-to-date time frame.

State of Backwardation

Apart from the supply constraints, the three products are poised to benefit from the positive roll yield in the coming months, as traders need to roll from one future contract to another in order to avoid physical delivery.

The roll yield is positive when the futures market is in backwardation (the price of the near month contract is higher than the next month futures contract) and negative when the futures market is in contango.

Though the lean hog futures market is currently in contango, it will soon shift to backwardation. This would be bullish for the commodity and the lean hog ETNs and the fund would probably roll over the next month futures contracts at a lower price, thereby making profits. A market in backwardation signifies that demand exceeds supply, shooting hog prices higher.

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