Keeping the ETF boom alive

NEW YORK (Fortune) -- Friday saw Deutsche Bank (Charts) roll out not one, but seven commodity sector exchange-traded funds (ETFs), demonstrating that the bank and its partner PowerShares Capital Management believe that ETFs and commodities will remain hot in 2007.

For the ETF industry, 2006 was a breakthrough year: The products caught on with investors looking to access far-flung economies, risky markets and sophisticated strategies that had been the province of hedge fund managers and professional traders.

ETFs trade like traditional stocks, so they're easy to use and make sense to the mom-and-pop investor. The assets in an exchange-traded fund are not managed, as they are in a mutual fund, but they track the rise and fall of an index. This means lower cost because there are no management fees.

And the industry rolled them out in droves. More than 150 hit the market last year, nearly doubling the number of ETFs.

Nowhere was this boom more apparent than in commodities. When prices soared in this asset class, ETFs gave retail investors access to those gains that had previously been available only to the wealthiest investors. In the case of commodities, ETFs reduce the complications and risks of futures markets and margin accounts.

And it doesn't matter if an investor thinks that commodities are overpriced. Since ETFs trade like stocks, they can be used by buy-and-hold investors, as short-term plays, as momentum investments and as hedges. ETFs have lots of shareholders that, like stockholders, can have completely different goals.

Little surprise, then, that the first gold ETF to hit the market, in November of 2004, has been a winner as gold sank then soared. streetTRACKS Gold Shares (Charts) is the eleventh biggest ETF around, in terms of trading volume, and it posted a 16% price gain in 2006 and a 33% run since its launch.

More gold and gold mining ETFs followed, along with funds for an array of silver and oil products, and demand stayed strong. According to Morningstar, the Energy Select Sector SPDR (Charts) is the third most active ETF, right behind the two ETFs that started it all, the NASDAQ 100 Trust Shares (Charts) and the SPDR (Charts).

Deutsche Bank, for one, believes that demand for commodity funds will remain strong. "We had good success with the Deutsche Bank Commodity Index Tracking Fund (DBC (Charts), which we introduced in 2006," says Kevin Rich, chief executive officer of DB Commodity Services. "It has assets over $700 million, and there were only three days out of the year with redemptions. That told us that there was investor interest coming into the fund."

And thus, on Friday Deutsche Bank and PowerShares launched PowerShares DB Agriculture Fund (DBA (Charts), PowerShares DB Base Metals Fund (DBB (Charts), PowerShares DB Energy Fund (DBE (Charts), PowerShares DB Precious Metals Fund (DBP (Charts), PowerShares DB Oil Fund (DBO (Charts), PowerShares DB Silver Fund (DBS (Charts) and PowerShares DB Gold Fund (DGL (Charts).

The first four funds are like commodity futures samplers: the Agriculture Fund, for example, tracks an index composed of futures contracts on some of the most liquid and widely traded agricultural commodities including corn, wheat, soy beans and sugar; the Base Metals Fund tracks futures contracts on aluminum, zinc and copper; and so on. The last three track futures for a single commodity - crude oil, silver or gold.

Rich believes that no matter how big the market for the ETFs, they will not affect the price of the underlying products. It's a fear that some market watchers have about gold ETFs that buy and sell the physical metal. The suspicion is that they helped propel gold prices higher because they made it much easier for retail investors to get direct exposure to the metal.

But there is little threat that this most recent spate of ETF offerings will cause bubble-like price moves in the industries that they track, says Rich, because they track futures contracts, rather than owning the physical commodity. "ETFs that buy the physical gold have a different dynamic effect on the market than our funds, which are futures-based," he says. "Futures reach expiration, so if there is a bubble, it should not be out there very long."

Still, others believe that ETFs can have an effect, on top of macroeconomic factors. "I don't think ETFs in and of themselves will drive commodities prices higher," says Ronald DeLegge, a former financial adviser with AIG who is now editor and publisher of etfguide.com. "If it's a race between China, India and ETFs driving commodities, ETFs will lose that race. But the effect of all three together will boost prices."

Of course, from the point of view of Deutsche Bank and other ETF market makers, rising commodity prices might just attract more mainstream investors, and keep the index investing boom going in 2007.

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