Commodity ETFs: Investing in Precious Metals, Agriculture, & Natural Resources

Key Takeaways


Commodity ETFs have gained popularity amongst investors in recent years, and it’s time to investigate why. Commodities are goods that are used as inputs into the economy. Think gold or silver — these are two prime examples of commodities. Commodities tend to rise in value when stocks and bonds decrease in value, and vice versa. This can be a great way to diversify a portfolio. They also help investors protect themselves against inflation.

Historically, directly investing in commodities was perceived as risky and costly. Commodity ETFs have helped remove some of these barriers. By investing in an ETF, beginner and intermediate investors don’t have to learn how to buy futures or other derivative contracts. They too can enjoy the benefits that commodities have to offer. Intrigued? Keep reading to learn the ins and outs of commodity ETF investing.

Commodity ETF funds

What Is A Commodity ETF?

A commodity ETF (exchange-traded fund) is a stock-traded fund that is invested in physical commodities. Commodities are economic inputs such as natural resources, precious metals, and agricultural products. Most ETFs are focused on just one type of commodity, but the way they are invested can vary. Some can hold the commodity in physical storage, in futures contracts, or track their performance by index.

Commodity ETFs are rapidly gaining popularity because they offer newbie investors a way to get into the commodities game with lower cost and risk.

Typically, if you were to invest in a commodity ETF, you won’t own the physical asset itself. Instead, you are investing in contracts that are backed by the commodity. Because commodities are so different from other types of stocks, commodity funds often create their own indexes. This helps investors benchmark just agricultural goods, or just metals, for example.


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The 4 Types Of Commodity ETFs

There are four different types of commodity ETFs that you should be aware of. As always, each type of investment has advantages and drawbacks. Your choice will depend on your personal investing goals, as well as your budget and risk tolerance. Here are the four types, immediately followed by an explanation of each:

  1. Equity ETFs

  2. Exchange-traded notes (ETNs)

  3. Physically-backed funds

  4. Futures-based funds

1. Equity ETFs

There are commodity funds that invest in companies that either produce, transport, or store commodities. These are referred to as equity ETFs or equity-based funds. These funds allow investors to get access to a specific sector, or multiple companies, but in a way that’s much less expensive than investing in the companies themselves.

This also provides a way to invest in commodities indirectly. By investing in an equity fund, the risks associated with physical and futures commodity ETFs can be avoided. Also, equity fund expense ratios tend to be less costly. One disadvantage to equity ETFs is that the investor gets removed from the commodity by one layer.

2. Exchange-Traded Notes

The second type of commodity ETF is exchange-traded notes, or ETNs. This is unsecured debt, issued and backed by a bank, that has a maturity date. ETNs match the returns of an asset by investing in stocks, bonds, and options. The investor only has to pay capital gains when the ETN is sold, so this is a great option if you’re looking for a better tax structure. When investing in ETNs, be sure to research the bank and evaluate its credit quality.

3. Physically-Backed Funds

As you might have guessed, physically-backed ETFs hold physical commodities in their possession. As of now, these are limited to precious metals. Having physical possession of a commodity eliminates both tracking and counterparty risk.
Investopedia defines tracking error as the instance when an investor experiences a divergence between their returns, versus what they were benchmarking their fund’s performance against. According to the Office of the Comptroller of the Currency, counterparty risk is the likelihood that the other party in an investment transaction wouldn’t uphold their end of a deal or contractual obligations.

Based on these definitions, tracking and counterparty risk are something to be avoided as much as possible. Therefore, physically-backed funds appear quite attractive. However, investors should note that these can be the costlier option. Because the asset being held is physical, there are costs associated with delivery, storage, and insurance. These costs can add up quickly. In addition, precious metals are taxed as collectibles (taxed at the marginal tax rate), which is something to keep in mind as well.

4. Futures-Based Funds

Last but not least, futures-based funds are arguably the most popular type of commodity ETF. As the name indicates, these ETFs invest in a portfolio of futures, forwards, and swaps on the associated commodities. Investors enjoy not having to pay the costs associated with physically holding, storing, or insuring the commodity. However, you’ll want to be careful of the risks associated with futures contracts themselves.

Most futures-based funds are incorporated as limited partnerships. Therefore, 60 percent of capital gains are taxed as long-term gains, while 40 percent are taxed at the ordinary rate.

The Risks Of Commodity ETFs

We’ve discussed some of the unique risks associated with the four types of commodity ETFs. It’s important to discuss the risks of commodity ETFs overall. First, these funds are usually either in contango or backwardation. Contango means that the price of the commodity will be higher in the future than for what they are currently priced. In backwardation, the price of the commodity will be lower in the future.

When an ETF is in contango, that means that it will be selling futures nearing expiration at a lower price and buying futures at a higher price. (The term is “negative roll yield,” if you want to get sophisticated.) This cost reduces returns and can cause the ETF to drag, making it difficult to track the commodity’s spot price.

When an ETF is in backwardation, the ETF will incur high expenses because it needs to roll over futures contracts constantly. This can cause the expense ratio to increase. The typical ratio of an unleveraged ETF can range from 0.5% to 1%, while leveraged ETF expense ratios can be anywhere from 1% and above.
ETFs sometimes influence futures prices on their own due to their need to trade large volumes of contracts. Because these trades happen on a predictable schedule, traders can bid prices up or down, putting the ETF at their mercy. Finally, these funds can be limited in size due to trading regulations.

Commodity ETF Example

Commodity trading is a large umbrella, but some of the most popular examples include precious metals, oil, and natural gas. Within the metals category, investors love gold and silver. Why, you ask? The answer might surprise you because it is so practical: gold and silver can’t spoil or go bad!

Are Commodity ETFs A Good Investment?

Are commodity ETFs a good investment, despite the risks? Commodities are a great way to balance out your portfolio and diversify risk. This is because historically, commodities as an asset have a negative correlation against other assets, such as stocks or bonds. That means that when the value of one asset class goes up, the other goes down, and vice versa. Commodities also help hedge against inflation.

If you are interested in getting some exposure to commodities in your portfolio, ETFs are the way to go. You can enjoy the benefits that commodities have to offer, without putting yourself at the risk of investing in them directly.

Best commodity ETF

The 10 Best Commodity ETFs To Invest In

Some investors also like to invest in commodity ETFs because they feel like they are investing in the very fabric of the economy. By investing in commodity funds, you’re taking a stake in the very supply chain of industry. Interested in getting started but not sure how? Here are the top ten commodity ETFs to invest in, according to experts:

  1. SPDR Gold Trust

  2. iShares Silver Trust

  3. Aberdeen Standard Physical Silver Shares ETF

  4. Aberdeen Standard Physical Palladium Shares ETF

  5. United States 12 Month Oil Fund

  6. United States 12 Month Natural

  7. Invesco DB Base Metals Fund

  8. Teucrium Corn Fund

  9. Teucrium Soybean Fund

  10. Invesco DB Commodity Index Tracking Fund

SPDR Gold Trust

Gold is a precious metal that won’t spoil or go bad. However, buying and holding gold yourself is a hassle – there is always the risk of theft, it takes up a lot of space, and you’ll need to insure it. Not to mention, it’ll be tough to sell. If you want to invest in gold, consider investing in a gold ETF such as the SPDR Gold Trust (GLD) to take the pain points out of investing in gold.

iShares Silver Trust

If you thought gold was difficult to store, you’ll be thinking again if you try to store silver. For the same dollar value, you’ll end up storing around 100 times more silver coins or bars than you would in gold.

Silver and gold perform quite differently on the market. Silver tends to have more common applications in industry, such as solar panels, medical devices, and electronics. iShares Silver Trust (SLV) is a fund that holds physical silver and operates similarly to GLD mentioned above.

Aberdeen Standard Physical Silver Shares ETF

Aberdeen Standard Physical Silvers Shares ETF (SIVR) is a silver ETF that is structured as a grantor trust. This means that investors own the right to a particular amount of silver. This fund is backed physically. Investors enjoy realistic pricing of silver, without dealing with the risks associated with futures contracts.

Aberdeen Standard Physical Palladium Shares ETF

Aberdeen Standard Physical Palladium Shares ETF (PALL) is structured very much the same as its SIVR counterpart from above. It is interesting to note, however, that pure palladium miners no longer exist. Investing in PALL is one of the only ways to access palladium, aside from futures contracts. Palladium is closely tied with the global auto industry, so make note that its price can swing dramatically.

United States 12 Month Oil Fund

When someone brings up the terms “commodity” or “raw material,” you might immediately think of oil. (Perhaps due to iconic movies such as Giant, or Hell or High Water.) Crude oil futures are measured in volume and open interest, making them one of the most liquid in the commodities market. USL, or United States 12 Month Oil Fund is one of the top oil funds. The way it is structured has helped minimize volatility, thus making it more popular than some of its counterparts.

United States 12 Month Natural

There’s USL, and then there’s UNL. United States 12 Month Natural tracks liquid natural gas instead of crude oil. This ETF tracks natural gas prices by holding a year’s worth of futures contracts. Natural gas production has spiked due to tracking and other technology.

Invesco DB Base Metals Fund

DBB, or Invesco DB Base Metals Fund, offers a way to invest in a mix of common metals. DBB holds futures that are backed by zinc, copper, and aluminum. These metals are used far and wide across many industries. Wires, pipes, zippers, instruments, car engines…any product you can think of, and most of the time, at least one of these metals will be involved. The price of these metals goes up and down alongside industrial trends.

Teucrium Corn Fund

The United States’ agricultural industry would look wildly different if corn were absent from it. As an agricultural commodity, corn is in high demand worldwide. According to the Department of Agriculture, a record 97 million acres of corn were planted in 2020. Because it’s difficult to invest in corn crops directly, the Teucrium Corn Fund (CORN) provides investors access to this commodity. CORN uses futures contracts and helps to take a lot of guesswork out of the equation for investors.

Teucrium Soybean Fund

Soybeans represent another global commodity that is high in demand. Much like corn, the U.S. agricultural industry supplies a large proportion of this demand. The Teucrium Soybean Fund (SOYB) is the sister fund to CORN and opens the doors for investors to invest in soy. This small bean has drawn much attention recently, through trade negotiations between the U.S. and China.

Invesco DB Commodity Index Tracking Fund

If you’ve been doing your homework on commodities, have weighed your options, and still can’t make a decision, then the DBC fund may be the perfect answer for you. The Invesco DB Commodity Index Tracking Fund (DBC) represents futures contracts of the world’s 14 most traded commodities in the world. The fund is backed by a wide range of metals, grains, energy, and other goods. The DBC can be a great way to gain exposure to a wide range of commodities and not having to weather the ups and downs of any specific one.

Summary

Commodity trading can seem a little old school, but commodity ETFs have modernized how investors can gain exposure to precious metals, agriculture, and other goods. By investing through a fund, you won’t have to be like Scrooge McDuck and hoard obscene amounts of gold somewhere in your house. Instead, you can enjoy the benefits of commodities without the hassle associated with owning a physical asset by investing in a fund. ETFs offer better pricing options, are less risky, and offer diversification. If you’re interested, why not try one of the top 10 commodity ETFs we listed above?

If you were to invest in a commodity ETF, which one would you pick, and why? Let us know your thoughts in the comments below!

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