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Welcome To The Downside Of The ETF Revolution

Sign of the times? Charles Biderman at TrimTabs tells me that Natural Resource Exchange Traded Funds (ETFs) have redeemed 5.8% of their assets ($2.1 billion) in the first 7 days of August.

What's up? The commodity selloff. Commodity ETFs like the PowerShares Deutsche Bank Commodity Fund (DBC) saw big inflows from the beginning of the year into July as everyone sought to get long energy, grain, and metals. Many professional traders use the ETFs to get long not just commodities, but the stocks underlying them as well.

Here's the problem: not only did commodities drop, but many traders long say, oil futures contracts, got repeated margin calls as oil went from $147 in July to $114 today. Some were forced to sell the ETFs they were long to cover their margin calls.

Remember how margin calls with oil contracts work: a single futures contract is 1,000 barrels. You can control a single contract for about $10,000. So if oil is $125 a barrel, you can control $125,000 worth of oil for just $10,000. Not bad.

As long as prices are stable or moving up, but if it drops just $10 a barrel, then your $10,000 investment is wiped out completely ($10 x 1,000 barrels = $10,000). Long before that, though, you will have received margin calls.

Welcome to the downside of the ETF revolution.


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