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Commodity ETFs Work

05 Jan 2023

What is a Commodity Exchange-Traded Fund (ETF)?

A commodity Exchange Traded Fund (ETF) invests in commodities like precious metals, agricultural goods, natural resources, and so on. Commodity exchange-traded funds (ETFs) invest in commodity futures contracts or a particular commodity stored in physical storage.

Other commodity ETFs, on the other hand, monitor the performance of a broad commodity index that includes a range of particular commodities. These ETFs are popular among aggressive investors and  traders trying to benefit from a plunging stock market or hedge against inflation. These ETFs include risk and do not assure returns. Also, commodity ETFs provide investors with exposure to commodities without the need to purchase futures or derivatives contracts.

Commodity ETFs: How Do They Work?

Commodity ETFs are extremely liquid schemes that may be traded on the stock market. Rather than bonds or stocks, these ETFs invest in commodities. These ETFs typically gain commodity exposure via futures contracts, but they may also own real commodities. Commodity ETFs are popular because they make it easier for investors to invest in commodities. Commodity futures trading is often complex.

Commodity ETFs are asset-backed or futures contracts that follow the performance of a single or a group of commodities. These contracts reflect and monitor the commodity's performance. Investing in these exchange-traded funds does not provide direct ownership of the commodity. When you purchase a Gold ETF, for example, you are not acquiring gold bars. You are only purchasing a gold-backed Exchange-Traded Fund (ETF). Commodities may be a useful alternative investment when other asset classes, such as bonds and shares, do not perform well. A negative correlation exists between stocks, commodities and bonds. As a result, these ETFs provide high diversity.

Who Should Buy Commodity ETFs?

Purchasing this ETF does not provide actual asset ownership. Rather, you own the collection of contracts backed by the commodity. During moments of high volatility or uncertainty in the economy, most investors purchase commodities to diversify their portfolios or for tactical reasons. Some commodities, like oil, are strongly linked to economic health, while others, such as gold, are not.

Before investing in a commodities ETF, it is critical to understand its aim. Commodities may be considered as hedging investments for experienced investors due to their negative correlation with bonds and equities. Furthermore, these ETFs can be low-cost investment vehicles for investing in asset groups that would otherwise be inaccessible. 

Things to Think About As an Investor

Consider the following factors while investing in commodities ETFs:

  • Performance in the Past - Past performance does not guarantee future results. Commodity prices are often volatile. Analysing the past performance and examining commodity price fluctuations over time, on the other hand, can assist you to comprehend their vulnerability to external influences.


  • Investment Purpose - Before investing in commodities ETFs, learn about the investment objectives. You should have a defined investing plan in mind when choosing a commodities ETF. Choosing the best commodities exchange-traded fund for your financial goals is crucial.


  • Cost - Commodity funds provide a low-cost and accessible option to invest in commodities. Commodities may be readily invested without the need to purchase futures or derivatives contracts. Which would otherwise be time-consuming and costly.


  • Risk - These are high-risk investing vehicles. Markets might be in backwardation or contango. Contango occurs when futures contract prices in the futures market are higher than spot market prices. When a commodity is in backwardation, the present price is more than the future price. When a futures market is in contango, the rolling risk is 'negative.' It indicates that the commodities ETF will sell lower-priced futures contracts that are about to expire and acquire higher-priced contracts. As a consequence, the roll yield is negative. Purchasing higher-priced futures reduces total profits. As a result, before investing in one of these ETFs, it is critical to examine the risks involved.

Benefits of Commodity Exchange Traded Funds

The following are some of the benefits of investing in commodities ETF funds:

  • Diversification: These ETFs may help diversify your investment portfolio. These ETFs provide exposure to commodity contracts backed by gold, oil, gas, precious metals, agricultural goods, and other commodities.
  • Real-time Prices: These ETFs are publicly traded on the stock exchange. As a result, they can be purchased and sold at any moment during trading hours.
  • Passively Managed Funds: These ETFs are managed passively. The funds intend to carefully monitor the underlying commodity's price changes.
  • Hedging: Commodities are useful for hedging since they have a negative correlation with stock and bonds.
  • Low Cost: These ETFs are low-cost investment vehicles. Commodity investing may be costly and time-consuming. It is also necessary to have prior expertise working with futures and derivatives transactions. Commodities' ETFs are passively managed funds since they follow a commodity index. As a result, as compared to actively managed plans, the cost of fund management is minimal.

Wrapping Up

Commodity ETFs provide investors with exposure to commodity markets without the need to trade commodities or derivatives. Commodity ETFs may provide tax advantages over acquiring derivatives or commodities directly. So, if you want to get into the commodities market, you need first identify the best commodity broker that suits your needs. You may begin trading in the commodities market after opening a commodity account with them.

Related Articles: MCX Meaning - Learn What is MCX, Its Advantages, and More | Who Sets the Price of Commodities? | Are Commodities a Good Investment Now? | The Top 3 Commodities and How to Buy Them

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