What Are Commodity ETFs?

Commodities such as gold, silver or oil can make great investment opportunities, although many investors find the price prohibitively high. One solution may be found in commodity ETFs, which allow investors to purchase a small bundle of commodities or commodity securities.

To learn more about commodity ETF options, you might consider using with an investment platform that offers research tools and other investment resources. 

In the meantime, the following information can serve as a quick tutorial, to explain how adding commodity ETFs can increase diversity and might offer a potential hedge against risk.

Understanding Commodity ETFs

A commodity exchange-traded fund (ETF) is a collection of securities that functions similarly to a mutual fund. An ETF generally offers greater flexibility than a mutual fund and trades much like individual stocks. 

Commodity ETFs refer to collections of securities that reflect raw materials such as gold, silver, oil, natural gas or agricultural supplies.

Provide Diversification

Because commodity ETFs provide you with a bundle of securities, this eliminates the need to select individual stocks. However, it also provides built-in diversification within the commodities sector. This can help you manage risk since the performance of one security within the ETF can offset the performance of others, helping you achieve balance within your portfolio.

Alternative Investments

Commodity prices are often negatively correlated with other asset classes. In other words, when other stocks go down, commodity prices typically rise, which can make them a choice alternative investment option. 

For example, in 2022, the Dow Jones Industrial Average fell by roughly 9%. But the price of oil rose from $10.17 per barrel in 2020 to $90 per barrel in 2022 — at one point reaching $120 per barrel.

Hedge Against Inflation

Because commodity prices negatively correlate with other securities, they can hedge against inflation. For example, copper prices, long regarded as an indicator of economic health, did not fare well in 2022, but analysts expect a resurgence for 2023. 

This comes in spite of the historic inflation that the U.S. economy has seen in the last year. At present, the Russia-Ukraine war is expected to drive up the cost of commodities, even while the global supply chain continues to hit snags.

Cheaper Way to Access Asset Classes

Commodities tend to be difficult to invest in. That’s especially true for gold or precious metals whose price can be prohibitive for the average investor. Commodity ETFs can put these assets within easier reach, which provides an affordable way to invest in these asset classes.

Types of Commodity ETFs

Several different types of commodity ETFs are available. Here’s an overview of each.

1. Physically Backed Funds

Physically backed funds hold the commodity itself. This type of fund is most common with certain types of commodities like gold, silver or other precious metals.

2. Futures-Based Funds

Futures-based funds are traded directly on an exchange and refer to contracts to purchase commodities at a predetermined price in the future. When the date arrives, investors often roll the contract and exchange it for another futures contract with a later date.

3. Equity-Based Funds

Equity-based funds don’t invest in commodities directly but in companies that are associated with the commodity. For example, an equity-based fund might reflect a company that stores or extracts the commodity itself, such as a company that mines copper or drills for oil.

Examples of Commodity ETFs in the Market

Various types of commodities are available, and you can generally find an ETF for each type. Some of the most common categories include these:

• Natural resources (oil, natural gas)
• Precious metals (gold, silver, copper)
• Agricultural supplies (fertilizer, seed)

Because an ETF is designed to be a collection of securities, it’s not unusual to find ETFs that include a small variety of commodities of the same class, such as commodity ETFs that focus on natural resources or precious metals.

Things to Consider in Commodity Investment

While commodity ETFs offer numerous advantages, investors would be wise to note the following:

• The value of futures contracts can be uncertain because of the large trading volume.
• Commodities can be volatile, subject to forces that don’t affect other stocks.
• Some commodities are considered collectibles and taxed at higher rates.

But these factors aren’t necessarily deterrents. Every investment class has its pros and cons, and many investors still find that commodity ETFs can make up a valuable part of a diverse, well-balanced portfolio.

A Solution for a Diverse Portfolio

If you’re looking to add diversity to your portfolio or hedge against inflation and risk, commodity ETFs can be a solid choice. The right investment platform can help you research and monitor your ETFs so that you can make well-informed choices about your investments.

Frequently Asked Questions