Investing in Commodity ETFs: Agriculture, Oil, Gold ETFs, & More

Find out more about investing in commodity ETFs, including what they are, things to research, and some of the common types of these investment products.

https://tickertapecdn.tdameritrade.com/assets/images/pages/md/Investing in commodity ETFs
7 min read
Photo by iStockphoto.com/Art Wager

Key Takeaways

  • Commodity ETFs are designed to track the movement of oil, gold, grains, livestock, and other commodities 
  • Some commodity funds are ETFs and some are ETNs; some invest in physical products, while others use futures contracts
  • If a commodity ETF uses futures contracts, contango and “roll yield” can affect fund performance

Bullish on gold? Bearish on oil? Think lean hog prices are going to rally? Okay, the average investor usually isn’t too focused on the outlook for lean hogs, but that isn’t necessarily the case for gold, oil, and other commodities. It didn’t take too long after the launch of the first exchange-traded fund (ETF) in 1993 before commodity ETFs became available. According to ETF.com (an ETF data and news subisidiary of Cboe Global Markets), as of June 2020, there are 137 different commodity ETFs, with total invested assets of $121 billion.

But as with any investment, ETFs tracking gold, oil, agriculture, and other commodities aren’t without risk. It’s important to research and understand them before you make a decision. This overview isn’t exhaustive for your due diligence, but it’s a good starting point.

What Are Commodity ETFs?

Commodity ETFs are a type of exchange-traded fund. An ETF is a group of securities that’s designed to track an underlying asset or index and can be traded intraday like an individual stock. ETFs may invest in physical commodities such as grains, livestock, energy, or precious metals. Some types of ETFs actually hold the commodities in physical storage. For others, although they’re referred to by the general term “ETF,” they’re technically exchange-traded notes (“ETNs”—more on that below). Many funds use futures contracts—standardized contracts for future delivery that are traded on futures exchanges such as CME, CBOT, and NYMEX (three exchanges owned by CME Group).

There are also some ETFs that do both—they invest in physical commodities and use futures contracts.

ETFs can make it easier to gain exposure to commodity markets without having to trade futures or deal with purchasing (and storing) physical raw commodities such as oil or precious metals. Over the long run, commodities tend to provide uncorrelated returns compared to stocks and bonds, which is why some investors choose them for additional diversification. In the past, commodities have performed well during periods of high inflation, leading some investors to invest in them as a potential hedge against inflation. However, just because they performed well under certain conditions in the past doesn’t mean they’ll do so in the future.

ETFs vs. ETNs

In addition to ETFs, there are also commodity ETNs, which often get lumped together in discussion (sometimes under the umbrella of exchange-traded products, or ETPs). Although both ETP types are traded on exchanges, ETNs are debt securities, whereas ETFs are investment funds. The performance of an ETN tracks an underlying index, like some ETFs; however, because an ETN is essentially a tradable loan issued by a financial company, investors are exposed to credit risk. That’s the possibility the issuer could default, resulting in a loss of principal. And that’s not the only risk you might want to consider with these products.

First, there’s always the chance your investment could lose value. Commodities can be very volatile and are affected by world events, government regulations, changes in import and export policies, and economic conditions. On top of that, production for certain commodities can be concentrated in foreign and emerging markets, which can be disrupted by political, economic, and currency instability. With each individual issue, there will be different risks you should consider. Before you invest, you should always read the fund prospectus to help you know what you’re getting into.

Researching Commodity ETFs/ETNs

The prospectus is a great place to start to learn more about a specific ETF/ETN you’re considering. It’s a document that must be filed with the Securities and Exchange Commission and provides additional information about risks, past performance, portfolio holdings, investment strategies, management, distribution policies, fees, and expenses, as well as other supplemental information.

After reading the prospectus, examine how the product you’re considering is taxed, which can vary depending on your individual situation and how the investment is structured. Some commodity ETFs will issue a Schedule K-1 to investors, which is a tax document used to report a partnership’s incomes, losses, and dividends. This can add more work and complexity when it comes time to file your taxes. These products are complicated, and if you aren’t sure you understand the tax implications, you might want to consult with a tax professional before investing.

On top of the prospectus and taxes, you may want to review how well the fund’s performance tracks the performance of the underlying asset or assets it’s supposed to be following. Expenses and other factors can cause a fund’s performance to diverge from the asset or index it’s supposed to be tracking. 

Finally, researching what drives commodity prices is essential before trading or investing. Commodity prices tend to be cyclical, driven largely by supply and demand. Global macroeconomic conditions, weather, and shifts in technology are just some of the things that can impact supply and demand—ultimately leading to shifts in price.

Contango and Commodity ETFs/ETNs

If you’ve researched these products, you’ve probably come across the word contango. The concept behind this funny-sounding word can have a substantial impact on the performance of ETFs/ETNs that use futures.

Remember that a futures contract is an agreement to buy or sell an asset (oil, gold, etc.) at a predetermined date in the future. In general, futures prices differ from spot prices, that is, the real-time cash price. If a futures contract price is higher than the spot price, this is called contango.

For example, crude oil is said to be “in contango” when longer-dated contracts trade at increasingly higher premiums over cash (spot) prices. Sometimes that premium exists because investors are willing to pay more for the commodity in the future rather than buy the commodity today and pay costs associated with storage. As the contract gets closer to expiration, this premium begins to “decay,” until the price of the expiring futures contract matches the cash price.

So what does that have to do with you investing in commodity ETFs/ETNs? You’re essentially investing in futures contracts if they’re in the ETF. As a fund’s near-term futures contracts approach expiration, certain contracts may need to be rolled over into longer-term futures delivery dates so the fund isn’t forced to take physical delivery of a commodity.

When the market is in contango, fund managers end up paying more for the longer-term contracts than what they receive from selling the shorter-term contracts, which results in the net price of your investment going down. This is called “negative roll yield,” or simply “roll decay,” and it can really add up over time and negatively affect returns.

Common Types of Commodity ETFs/ETNs

Although there’s a wide variety among these products, most of them tend to fall within these broad categories:

  1. Agriculture ETFs focus on agricultural goods, such as cocoa, sugar, wheat, corn, soybeans, coffee, cotton, and hogs. In the short term, agricultural commodity prices can be quite volatile depending on weather, among other factors. Depending on where production for a specific commodity is concentrated, geopolitical concerns can also come into play. Unlike other commodities, spoilage can be an issue with agricultural goods, adding another risk to consider with agriculture ETFs.
  2. Energy ETFs include natural gas, gasoline, and oil ETFs. Investors who are bullish on long-term energy consumption and economic growth might consider these. Energy prices can be impacted by seasonal conditions; for example, natural gas demand usually goes up if it’s a particularly cold winter or down if it’s a warm winter.
  3. Precious metals ETFs include those based on gold, silver, platinum, palladium, or some combination. Some of these metals are used in jewelry and industrial applications, but a large portion of available supply is held by governments and individuals throughout the world. Some investors use them as a potential hedge against inflation or when markets are volatile.
  4. Industrial metals ETFs encompass nonprecious metals used in industrial applications: copper, nickel, tin, and aluminum. Investors might choose different industrial metal ETFs if they’re bullish on overall economic growth or specific industries that require these metals in their operations.  

Bottom Line on Commodity ETFs

This is just a high-level look at the different commodity categories. Within each of these, you’ll find a variety of products. If you’re considering any of these types of investments, the ultimate question is whether or not they fit into your investment strategy.

The key is to think strategically instead of tactically. Commodities can work well in a diversified portfolio because of the alternative investing exposure they provide versus stocks and bonds. Trying to time fluctuations in commodities in the short term can potentially whipsaw your portfolio. But a core holding might be a good hedge during times when stocks or bonds are unable to provide that stability. 

With commodity ETFs—or any alternative investment, for that matter—a little might go a long way. Given how volatile commodities tend to be, if you’re interested in adding these products, an appropriate allocation is important. Companies involved in the commodities supply chain (think oil companies, gold miners, and those involved in food production and distribution) might offer the same type of diversified exposure, but with potentially less volatility. Again, it’s all about your personal objectives, risk tolerance, and investment horizon.  

*Before investing in an ETF, carefully consider the fund’s investment objectives, risks, charges and expenses. For a prospectus containing this and other important information, contact the fund or contact a TDAmeritrade Client Services representative at 800-669-3900. Please read the prospectus carefully before investing.

Print

Key Takeaways

  • Commodity ETFs are designed to track the movement of oil, gold, grains, livestock, and other commodities 
  • Some commodity funds are ETFs and some are ETNs; some invest in physical products, while others use futures contracts
  • If a commodity ETF uses futures contracts, contango and “roll yield” can affect fund performance

Related Videos

Call Us
800-454-9272

Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.

Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

ETFs are subject to risk similar to those of their underlying securities, including, but not limited to, market, sector, or industry risks,and those regarding short-selling and margin account maintenance. 

Commodity ETFs may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Commodity ETFs may be subject to greater volatility than traditional ETFs and may not be suitable for all investors. Unique risk factors of a commodity fund may include, but are not limited to the fund’s use of aggressive investment techniques such as derivatives, options, forward contracts, correlation or inverse correlation,market price variance risk and leverage.

ETNs are not funds and are not registered investment companies. ETNs are not secured debt and most do not provide principal protection. ETNs involve credit risk. The repayment of the principal, any interest, and the payment of any returns at maturity or upon redemption depend on the issuer’s ability to pay. The market value of an ETN may be impacted if the issuer’s credit rating is downgraded. ETNs may be subject to specific sector or industry risks. Leveraged and inverse ETNs are subject to substantial volatility risk and other unique risks including leverage, derivatives, and complex investment strategies that should be understood before investing. ETNs containing components traded in foreign currencies are also subject to foreign exchange risk. ETNs may have call features that allow the issuer to call the ETN. A call right by an issuer may adversely affect the value of the notes.

TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.


adChoicesAdChoices

Market volatility, volume, and system availability may delay account access and trade executions.

Past performance of a security or strategy does not guarantee future results or success.

Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.

Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.

This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.

TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2020 TD Ameritrade.

Scroll to Top