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Commodity Exchange Traded Funds
Exchange Traded Funds (ETFs) are far better known than ETCs. While ETCs give you exposure to commodities, ETFs do the same thing but with securities instead. Like an ETC, you’re investing in or trading on a financial product that tracks the performance of underlying assets without you having to take ownership of any of them.
However, a commodity ETF will take their price from futures contracts of that commodity, rather than containing the physical asset.
Investing directly in commodities futures can be both impractical and expensive. There’s even the occasional report of a trader who has forgotten to close a futures position who is forced to take physical delivery of a commodity.
Further, futures themselves are relatively complex, typically have large contract sizes, come with margin demands, and include a component of open-ended risk that needs to be covered by the trader. This can make them unattractive to some retail investors, especially those without starting their investing journey.
Most commonly, commodity ETFs they track a benchmark index which either measures the price of a single commodity or a basket of multiple commodities. Most are synthetic ETFs which track commodity futures, and therefore may perform better or worse than the spot price of the commodity itself. Of course, some commodity ETFs will directly invest. However, this is the exception, rather than the rule.
One of their key advantages is diversification, as many Commodity ETFs invest in a basket of commodities or commodity-producing companies, spreading risk across multiple assets.
They are also highly liquid, trading like stocks on major exchanges, and physically-backed ETFs eliminate counterparty risk by holding the underlying commodity directly. Additionally, ETFs can offer tax benefits depending on their structure and jurisdiction. However, Commodity ETFs may face tracking errors, particularly when investing in futures or related equities, as these assets don’t always perfectly mimic commodity price movements.
Furthermore, expense ratios for ETFs can be higher compared to ETCs, and their indirect exposure may dilute the pure impact of commodity price changes due to broader market trends.
When trading, it’s important to note that the relationship between commodities and stocks is not linear. Some commodity prices have an inverse reaction to stocks, while others move in a parallel direction. There are several factors that impact the price of the underlying commodities and stocks, such as market forces, weather patterns, and economic and political stability.