Traders Would Not Expect These ETFs To Carry Political Risks

Stemming from a lack of cross-border diversification, country-specific ETFs expose investors to some level of political risk. This holds particularly true in emerging and frontier markets.
 
For example, the primary reason for the Global X FTSE Argentina 20 ETF's (NYSE: ARGT) year-to-date loss of almost 21 percent is likely the country's growing reputation for hostility towards foreign companies looking to do business there.
 
However, political volatility does not begin and end with country or regional ETFs. As Argentina and a number of other countries have shown in 2012, some sector funds also expose investors to significant political uncertainty. Below are four of these politically-sensitive sector funds.
 
Market Vectors Coal ETF (NYSE: KOL) In regards to politics, the Market Vectors Coal ETF is a curious case because its political issues stem from the US government, rather than less stable emerging nation governments. In the US, 2012 is an election year and major coal-producing states such as Pennsylvania and West Virginia are viewed as swing states. That means President Obama and Mitt Romney may tell coal miners what they want to hear in an effort to gain their support.
 
Talk is cheap. So is natural gas. To this end, natural gas, an abundant commodity in the U.S., burns more cheaply than coal. Natural gas has political momentum, but it does not mean death for KOL and its constituents. This political momentum may mean, however, that U.S. coal companies will become more dependent on exports to emerging markets as profit drivers. Granted, that shift might only be possible if Chinese and Indian economies hit on all cylinders - a premise that is not currently occurring.
 
Global X Silver Miners ETF (NYSE: SIL) Approximately two-thirds of SIL's country weight goes to companies based in Canada, the U.K. and the U.S. As a result, the home docile of many of SIL's holdings may not be a source of significant political instability. Instead, silver miners may face political instability where they go to extract the white metal.
 
A generous assessment says three of the top-10 silver-producing countries are politically risky. That trio is Russia, Bolivia and Argentina, though some would argue and Peru and China belong are politically volatile as well. Within the list of the top-20 silver-producing nations, at least five others could be considered less-than-trustworthy at the political level.
 
Pan American Silver (NASDAQ: PAAS), SIL's fourth-largest holding, is facing some political headwinds in Argentina. This news highlights common risks involved with the production of precious metals.
 
ETFS Physical Palladium Shares (NYSE: PALL) Russia and South Africa dominate global palladium production. In 2009, the pair produced 85 percent of the world's palladium. Each nation presents investors with a different set of political challenges.
 
Of the palladium duo, Russia may be the more concerning. The country's palladium export data could be questionable. This forces many market participants to analyze Swiss customs data. Switzerland is a major hub for precious metals trading in Europe.
 
Beyond that, Russia may not be forthright regarding its palladium stockpiles. Assuming Russia has larger stockpiles than traders believe it has, the country could flood the market if palladium prices surge. Or, Russia may not want others to know if its palladium stocks are quite low. The country might withhold this information because its release would likely lead to a sudden jump in prices.
 
Both scenarios are speculation, but Russia's secretive nature regarding its palladium reserves only increases palladium price volatility.
 
iShares S&P Global Energy Sector Index Fund (NYSE: IXC) Of course, at least one oil ETF deserved to make this list. As is the case with SIL, the bulk of IXC's component companies are based in civilized, Western nations, such as the U.S. and the U.K. For oil equities, investors might be more concerned about where these companies go to generate profits.
 
Exxon Mobil (NYSE: XOM), the largest U.S. oil company, is IXC's largest holding with a weight of almost 16 percent. The company is embarking on a massive $500 billion deal in the Russian Arctic with OAO Rosneft. That anecdote only scratches the surface of the unsavory places global oil companies have to go to find crude.
 
Chevron's problems in Latin America, specifically Brazil and Ecuador, are well-documented. Royal Dutch Shell's (NYSE: RDS-A) assets and staff in Nigeria have been regular targets of rebel attacks. BP (NYSE: BP) and Total (NYSE: TOT), among other IXC holdings, are looking to expand their Libyan footprints. Anadarko Petroleum (NYSE: APC) does business in Ghana, Liberia and Mozambique, among other African nations.
 
The realities of the oil business dictate that oil majors search far and wide for new reserves. This search often requires these companies to travel to politically volatile places. Investors would be prudent to acknowledge these political risks before buying oil-related stocks or ETFs, such as IXC.

BY The ETF Professor