What Is a Commodity ETF?
A commodity ETF is a fund traded on the stock market that invests either directly in commodities, or using commodity derivatives. It often seeks to track the price movement of an underlying commodity or index. Popular commodity EFTs invest in oil and gas, silver, gold, or agricultural products.
Most commodity ETFs hold derivatives or futures rather than the commodity itself. Some do have direct holdings in commodities, with those assets usually stored in a vault somewhere. Some pursue exposure to only one commodity, while others hold a basket of commodities and change allocations over time. Commodity ETFs are perfect for investors who want to gain exposure to a commodity without having to purchase futures or commodities directly.
How Is a Commodity ETF Different From Other ETFs?
Conventional ETFs usually invest in bonds, stocks, and/or treasury certificate, and can be focus on a specific sector, market cap, or geography.
Commodity ETFs don't invest in stocks or bonds, but rather in commodities like gold, oil, or corn. These ETFs often gain exposure to commodities through futures, but sometimes hold the actual physical commodity. They are popular because they make it easy for investors with no experience purchasing futures to take a position in commodities that would otherwise be difficult to store or transact in.
Commodities sometimes perform well when other asset classes like stocks and bonds are not. A low or negative correlation between assets can provide diversification benefits. Many investors take positions in commodities to diversify their portfolio or for tactical reasons during volatile or uncertain economic periods. Some commodities are very leveraged to the health of the economy, such as oil, while others such as gold have little to no link.
Takeaway: While some commodity ETFs own and store physical assets like gold bars, most commodity ETFs gain exposure through positions in derivatives. Derivatives can create more regular tax liabilities, which is why some of these ETFs will operate via a subsidiary located in a tax-advantageous country.
Types Of Commodity ETFs
There are a number of different types of commodity ETFs. For example, investors can purchase ETFs that invest in only one commodity like gold, or others that invest in a basket of assets like different agricultural commodities.
Additionally, many stock ETFs provide indirect exposure through ownership of commodity producers. Another instrument for commodity investing is an exchange-traded note.
Commodity ETFs can be focused on any of the following, as examples:
1. Futures-Based ETF Funds
These types of ETFs buy futures, forwards, and swap contracts on the commodity they are investing in. Futures-based commodity ETFs tend to be the most common. One of the downsides to ETFs that invest in futures are the roll costs, which in some cases can be significant. On the other hand, this type of ETF doesn't have to bear the storage and security costs of directly holding the commodities themselves.
2. ETFs with Physical Commodity Holdings
ETFs that directly hold commodities can store them in a physical location. This can work well for non-perishable commodities like gold, silver, or platinum, but not for commodities like corn which cannot be stored for long periods of time. ETFs with physical holdings typically incur transportation, rent and security costs. On the other hand, these types of funds aren't exposed to the futures curve, which can result in significant rollover costs for futures-based ETFs.
3. Equity ETFs Which Invest in Commodities
These ETFs don't invest directly in commodities or their derivatives but instead purchase stock in companies that are associated with the production or transport of those commodities.
4. Exchange-Traded Notes (ETN)
These aren't technically ETFs. Instead, they are a debt instrument that is traded on the stock market. Here, a financial institution typically borrows money from the fund through a contract in which they agree to pay interest that is linked to the returns of a specified commodity. This type of investment carries credit risk since the bank in question could go bankrupt or default on their payments.
Takeaway: Commodity ETFs have different tax considerations. For example, ETFs that hold physical commodities are taxed at an investors marginal tax rate, if held long term, and ordinary income rates if held short term. In contrast, an ENT investor will only pay a capital gains tax when the investment is sold.
Example List Of Commodity ETFs
Here are some examples of well-known commodity ETFs, prioritized in largest to smallest by assets under management:
- Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC): largest commodity ETF by assets under management with $3.9 billion. Holds futures contracts for commodities and is actively managed. Holds a variety of commodities.
- Invesco DB Commodity Index Tracking Fund (DBC): second largest with $2.5 billion. Holds futures contracts for a diversified basked of commodities.
- iShares U.S. ETF Trust iShares GSCI Commodity Dynamic Roll Strategy ETF (COMT): Assets under management at $2.3 billion. Holds commodity derivatives in a Cayman subsidiary for tax purposes. They select 14 commodities each year to invest in.
- First Trust Global Tactical Commodity Strategy Fund (FTGC): Assets under management at $2 billion. Is actively management and invests in futures contracts through a Cayman subsidiary for tax purposes. Structured as an open-ended trust.
- KraneShares Global Carbon Strategy ETF (KRBN): Assets under management at $1.5 billion. Provides investors with exposure to cap-and-trade carbon allowances via futures contracts.
- iShares S&P GSCI Commodity-Indexed Trust (GSG): Assets under management at $1.3 billion. Heavily focused on energy resources such as crude oil, natural gas, and other energy commodities but invests in a diversified group of commodities.
- iPath Bloomberg Commodity Index Total Return ENT (DJP): Assets under management at $947 million. Has a broad-based exposure to commodities that includes things like energy commodities, precious metals, and agriculture. Structured as an exchange-traded note.
Commodity ETFs allow investors to gain exposure to commodity markets without having to transact in commodities or derivatives themselves. In some cases, commodity ETFs also offer tax-advantaged treatment over purchasing commodities or derivatives directly.