Montreal, Canada

Buyer beware!

That’s my message to investors heavily exposed to commodity futures Exchange-Traded-Funds (ETFs) and or Exchange-Traded-Notes (ETNs).

Over the last five years, ETFs have boomed worldwide. Assets for all ETFs are rapidly approaching the $1 trillion dollar mark with commodities absorbing about 30% of that total.

Yet the game is changing fast for investors in these products.

Recently, I’ve turned bearish on most commodity ETFs because investors are getting ripped-off. The sponsors of these products are making a killing. But that’s not the case for individual investors whereby the “contango” anomaly in the futures space coupled with fat fees has shed some sobering information about funds designed to mimic the performance of commodities futures contracts.

Hidden fees and premiums on many commodities futures contracts have altered the landscape for investors in ETFs over the past several months and that means investors are better off seeking commodity exposure elsewhere, as high fees dilute the total return equation. In some cases, these ETFs have total expense ratios in excess of 6%, meaning it takes at least a 6% return just to break-even.

ETF Securities, the largest service-provider of physically-backed commodity ETFs, is about to launch a base metals ETF. The listing, however, hasn’t been divulged at the time of the announcement but all indications point to either New York or London.

Once this new base metal ETF is launched, however, investors will have to pay to play. Finance and storage costs, including insurance fees, will comprise a significant share of the total expense ratio. Remember, you just don’t buy 25,000 pounds of copper and walk away; warehouse charges for storage are expensive, especially in London, which is home to the LME, or London Metals Exchange.

Copper is bound to be the biggest winner once this ETF begins trading as demand soaks up whatever supplies are left – and they’re shrinking again this fall as China returns to the market after hoarding the red metal the first half of 2010. China is the single largest buyer of all industrial metals over the past decade.

The bad news is that aside from copper, some industrial metals (aluminum and zinc) harbor higher cost-to-carry charges and don’t offer the same liquidity as copper. That means higher spreads and fees for retail investors in the ETF.

Worse, for bulkier metals, these products are not suitable for longer term investors since storage and opportunity costs of financing will eat deeply into expected returns.

To be sure, a few ETFs deserve to be in your portfolio, particularly the grains and the precious metals. But, for the most part, commodity ETFs and ETNs have become a raw deal for the retail investor.