What are commodities? Names may come across your mind: precious metals like gold, silver, and raw materials, e.g., oil and gas, nickel, agricultural products such as rice, corn, and regional greenhouse gas initiative. Nowadays, they are becoming winning germs for investors due to recent increases in values. Thus, instead of purchasing and storing physical goods, you may act smartly by investing in commodity exchange-traded funds (ETFs).
Besides being an alternative to physical commodities, you can gain exposure to different commodities through an ETF. An agriculture ETF lets you participate in corn, cocoa, and wheat investments. You can invest in more precious metals like gold and silver through an ETF. Commodity ETFs invest in physical assets and store them and sell them later, or actively trade futures-based contracts, swaps, and forward contracts to make profits.
How do ETFs Work?
An exchange-traded fund (ETF) is a collective investment scheme that tracks components from an index. It is a passively-managed fund. An ETF manager ensures the portfolio complies with the investment proportion and targets index. Therefore, the expense ratio is low, ranging from below 1% per year.
Investors buy ETFs because they want a hassle-free investing style and long-term growth with a market.
But it may not suit active investors for outperforming the market as an ETF is a market investment. Besides, short-term traders may miss opportunities by investing in an ETF as individual stocks may rise faster than a market index. Active investors may include ETFs in portfolios to diversify risks caused by sudden market changes.
What is a Commodity ETF?
A commodity ETF is an exchange-traded fund investing in commodities or derivative-related products like futures contracts.
Two types of commodity ETFs are popular among investors:
1. Physical commodity ETFs
The funds buy physical agricultural products, metals, oil, and cattle and store them in the vault. They sell for a profit at a later time. SPDR Gold Share is a physical commodity ETF.
2. Futures-based commodity ETFs
A manager of an actively-managed fund will trade commodity futures contracts on exchanges to make profits. A futures-based ETF doesn’t collect actual products. He rolls near-expiry contracts and buys a new one to extend contracts’ expiry dates. Interestingly, fund managers have to trade and extend expiring contracts at the end of futures cycles, leading to significant swings in futures markets. The regulator sets some limits on futures-trade activities as such.
You can buy the most popular commodity ETFs on stock exchanges. SPDR Gold Shares and iShares Silver Trust are the largest ETFs regarding precious metals in the commodity ETF market. Other popular choices include the SPDR S&P North American Natural Resources ETF and the SPDR S&P Global Natural Resources ETF.
Expense ratios
Commodity ETFs charge 0.15% to 1% depending on whether it is leveraged. Future-based ETFs may charge lower expenses due to trading costs only. Physical commodity ETFs may charge to cover the storage costs, while leveraged ETFs incur higher expenses to cover interest costs.
Commodity Indexes
Besides tracking physical assets, commodity ETFs also invest in components from commodity indexes. The indexes comprise commodities from the same category like precious metals, agricultural products, or natural resources. The Thomson Reuters/CoreCommodity CRB Index includes 28 farming products like cocoa and wheat. Nevertheless, commodity indexes track all products like industrial metals and natural resources. The S&P GSCI covers almost all commodities with a heavyweight of more than 50% on energy.
Why invest in a Commodity ETF
Pros
1. Saving costs
If you invest in precious metals like gold bars, you have to find a place to safeguard them. The costs of investing in gold bars are gold price + storage costs + transportation. A commodity ETF spares you effort by paying an expense only. A commodity ETF lets you participate in different commodities, including difficult-to-store ones like gas.
2. Diversification
Research shows you can diversify risks by including 10% to 15% of commodity investments into your portfolio. Commodities tend to perform reversely with other assets like stocks; the return by commodity ETFs has superseded stocks over the past year. Therefore, you should use essential investment skills to reduce portfolio risks.
3. Inflation hedging
Precious metals like gold and silver are insurance against inflation. Whenever the inflation rates rise, gold and other commodities follow suit more than the inflation pace.
4. Liquid investment
Commodity ETFs are highly liquid investments tradable by the net asset value or fund prices listed on the stock exchange. Continuous and latest quotes are available to reflect market updates. You find it easy to manage your assets through commodity ETFs.
Cons
1. Volatile pricing
Commodities have fluctuating price histories and are sensitive to numerous international factors. They can range from wars, geopolitics, demand-supply, and the pandemic. Therefore, commodity prices may undergo price swings in a short time, and you may suffer losses.
2. Capital gains only
Commodities do not pay income or dividends, unlike equity and fixed-income investments. Investors have only one source of growth: capital gains or price performances coming from a commodity itself. If you are looking for stable growth and income streams, commodity investing may not be ideal.
3. Cycle price volatility
Due to future roll schedules, investors may encounter futures-contract price swings. A typical futures contract lasts a maximum of 3 months. Numerous investors use the investment strategy of rolling their to-expire futures contracts and buying new contracts to extend their positions simultaneously every 3 months a year. The price may fluctuate due to the cycling roll schedules. The market may undergo ups and downs in a short time.
4. Differences in investment tracking
Commodity ETFs have distinct investment indicators. Some may track individual commodities; others pursue commodity indexes as their aims. If you own more than one commodity ETF, you should check their investment against their methodologies to ensure compliance.
What Commodity ETFs are available in Singapore
Singapore has only one commodity ETF to investors. You can invest in the SPDR Gold Share(SGX: 087, GSD). The symbols 087 and GSD stand for the same fund with 2 currencies. The former uses the US dollars for investing, while the latter uses the Singapore dollar.
1. SPDR Gold Share (NYSE Arca: GLD)
The ETF tracks gold bullion prices. The fund aims to reflect the commodity’s performance, and the net asset value is the price per unit less operating expenses. The ETF offers investors an effective alternative to physical gold bars. The expense ratio is 0.40% per year.
You can also find commodity ETFs in other international markets like the New York Stock Market. All you need is an investment account with a brokerage with access to global markets.
Below are other noteworthy commodity ETFs.
2. Aberdeen Standard Bloomberg All Commodity Strategy K-1 Free ETF (NYSE Arca: BCI)
The ETF covers a wide range of commodities, such as, Industrial metals, energy, precious metals, and livestock. It gives investors overarching exposure to popular commodities. The expense ratio is 0.25%.
3. United States 12 Month Oil Fund (NYSE Arca: USL)
The fund invests in oil futures contracts instead of physical assets. The recent tension crisis in oil has led to rising in return from the ETF. The futures contracts used have a lifespan of 12 months. Its expense ratio is 0.88%.
4. Teucrium Wheat ETF (WEAT)
The agricultural ETF, engaging in futures contracts and taking advantage of the rising wheat prices, has produced a year-to-date return of more than 40% so far. The war between Russia and Ukraine(the major grain exporters) and the worldwide middle-class growth increased wheat prices. The expense ratio is 1%.
5. Aberdeen Bloomberg Industrial Metals Strategy K-1 Free ETF (NYSE Arca: BCIM)
The fund invests in futures contracts of industrial metals like copper, nickel. Russia is the leading exporter of these essential industrial metals, and the conflict may lead to more increases in profits. The expense ratio is 0.39%.
Find out more on how to buy ETF in Singapore.
Final Thoughts
Commodity ETFs are collective trusts specializing in commodity investments. Their investing styles model against commodity prices or indexes. The advantages are reducing the costs of transporting and storing physical assets. However, investors should beware of the price fluctuations.
Key Takeaways:
- Gain exposure to commodity investments without owning physical assets
- Diversify your portfolio risk by including 10% to 15% of commodities
- Commodities are a good inflation hedge.
- Huge price fluctuations are of a commodity nature.
- Commodity ETFs are liquid investments rather than physical assets.
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