Summary: Investing in commodities can be a valuable addition to your investment portfolio, allowing you to diversify and potentially acting as a hedge against inflation. A simple and effective way to gain exposure to this financial asset class is through commodity Exchange-Traded Funds (ETFs), which give investors access to a broad range of commodities and related markets without the need to buy and hold physical assets or deal with complex futures contracts. In this guide, you will learn how to invest in commodities ETFs on online commodity trading platforms such as eToro.
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Commodity ETFs: Preliminary notes
Commodity ETFs, or Exchange-traded funds, are investment vehicles that provide you with exposure to the price changes of various commodities like gold, silver, cattle, and natural gas, among others, without the need to actively own and manage them. As such, they can be an excellent way to diversify an investment portfolio as you gain access to asset classes that may behave differently from stocks and bonds.
There are four primary types of commodity ETFs:
- Those that hold physical commodities: Physically-backed ETFs invest directly in the underlying commodity, such as gold or silver. For example, the iShares Gold Trust (IAU) holds physical gold, and its value is directly linked to the price of gold;
- Equity-based funds: Commodity ETFs based on equities involve holding shares in companies engaged in the production, transportation, and storage of commodities. Such ETFs offer investors exposure to multiple companies or specific sectors in a straightforward and cost-effective manner, as opposed to directly investing in the underlying companies;
- Those that track futures contracts: On the other hand, futures-backed ETFs invest in futures contracts of the respective commodity, allowing you to profit from their price movements without owning the physical commodity itself. An example would be the Invesco DB Commodity Index Tracking Fund (DBC), which holds a diversified portfolio of futures contracts across various commodities.
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Further subdivisions
Commodity ETFs can be classified into different commodity types depending on the specific assets they track. Here are some of the most common categories:
- Precious Metals: These ETFs focus on metals such as gold, silver, platinum, and palladium. Some popular examples in this category are the SPDR Gold Trust and the iShares Silver Trust;
- Energy: Energy ETFs invest in various energy sources such as oil, natural gas, solar, and wind. Examples include equity-based funds that hold stocks of energy-producing companies and those tracking an energy index;
- Industrial Metals: These ETFs concentrate on industrial metals like copper, aluminum, and zinc. They may either hold stocks of companies in the sector or track the performance of the underlying metals;
- Agriculture: Agriculture ETFs encompass a broad range of commodities such as soybeans, corn, wheat, and coffee. They typically invest in futures contracts or equities of companies in the agricultural sector;
- Livestock: Livestock ETFs provide exposure to the prices of live animals, such as cattle and hogs. These funds typically hold futures contracts for these commodities.
Naturally, you can also find specific commodity ETFs that focus on segments like energy, precious metals, or agricultural products. For instance, the Energy Select Sector SPDR Fund (XLE) provides exposure to the energy sector, while the SPDR S&P Oil & Gas Exploration and Production ETF offers a diversified portfolio of oil and gas-producing companies.
What are ETNs?
ETNs offer certain advantages. For example, index tracking errors between the ETN and its tracked asset are usually less common. However, there is the issue of the credit quality of the issuing institution.
How to invest in commodities ETFs: Step-by-step
To invest in commodities ETFs, you can take the following steps:
- Step 1: Choose a broker and fund your account;
- Step 2: Research the commodity market and ETFs;
- Step 3: Place your order;
- Step 4: Monitor your investment.
Step 1: Choose a broker and fund your account
To start investing in commodity ETFs, you will have to find a reputable broker and make an account.
Our go-to platform for all sorts of commodity ETFs is eToro, a popular brokerage with millions of daily users and features such as:
- Commission-free stock trading;
- Access to global stock exchanges;
- Charting patterns;
- Fractional shares;
- Copy-trading and Smart Portfolios.
Highly Rated Stock Trading & Investing Platform
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Invest in 2,800+ stocks and other assets including 70+ cryptocurrencies and commodities.
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0% commission on buying stocks - buy in bulk or just a fraction from as little as $10. Other fees apply. For more information, visit etoro.com/trading/fees.
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Copy top-performing traders in real time, automatically.
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eToro USA is registered with FINRA for securities trading.
Once you’ve made an account, you can start depositing funds you can use to buy ETFs. Most major brokers give users the option to fund their accounts via:
- Bank transfers;
- Wire transfers;
- Credit cards;
- Or third-party payment venues, such as PayPal.
Step 2: Research the commodity market and ETFs
Once you’ve funded your account, you can start doing research and figuring out what ETFs can help you realize your financial goals in the commodities market. Most importantly, you should evaluate the status of your current portfolio, figure out your risk tolerance, define your time horizon, and check the performance of various funds in the sector.
Step 3: Place an order
Finally, you can start placing orders and adding some ETFs to your portfolio. To do that, you can:
- Log into your brokerage account;
- Search for the commodity ETFs you wish to buy;
- Specify the amount you wish to invest;
- Review your order;
- Confirm and execute the order.
Step 4: Monitor your investment
Defining precise investment goals, selecting crucial performance indicators, and adding ETFs to your investment portfolio is only the beginning — you will also have to stay vigilant and monitor the performance of your investments.
To do so, you can make use of the portfolio tracking tools offered by your brokerage to evaluate metrics such as overall portfolio value, return rate, and the performance of individual assets. Furthermore, assess other investments in your portfolio by taking into account elements like earnings reports and market trends and try to diversify your portfolio as much as possible.
For more commodity ETFs, check out our guide on the top 5 commodities as well as our guides on:
- How to Invest in Copper ETFs;
- How to Invest in Wheat ETFs;
- How to Invest in Silver ETFs;
- How to Invest in Gold ETFs;
- How to Invest in Lithium ETFs;
- How to Invest in Natural Gas ETFs;
- How to Invest in Cobalt ETFs;
- How to Invest in Farmland ETFs.
Expenses associated with trading ETFs
You can trade ETFs in various ways. With a laddered strategy, fixed-income investments, each with progressively longer terms to maturity. Conversely, an optimized strategy revolves around futures contracts with the least contango and the most significant backwardation in an effort to minimize costs and maximize yields.
Both of these approaches may be suitable for long-term investors as they cut costs. However, this makes precise tracking less likely. Moreover, futures-based commodity ETFs face heightened expenses due to the continual rollover of futures contracts.
The actions of ETFs can impact futures prices as a result of their necessity to buy or sell substantial numbers of futures contracts at predetermined times. This is called a roll schedule, and it makes ETFs susceptible to the influence of traders who may manipulate prices in anticipation of ETF trade orders.
Are commodity ETFs a good investment?
Commodity ETFs offer numerous advantages when it comes to investing. They provide an opportunity for diversification by including commodities, a distinct asset class, in your portfolio. Many investors use commodity ETFs to hedge against inflation, as commodities tend to retain their value during inflation. This makes them a reliable store of value.
The key benefits of investing in commodity ETFs:
- Diversification: Investing in commodity ETFs provides an opportunity to diversify your portfolio. This asset class can offer a hedge against inflation and can be less correlated to traditional assets such as stocks and bonds. In turn, this may reduce the overall risk in your investment portfolio;
- Convenience: Commodity ETFs allow you to gain exposure to the performance of various commodities without actually owning the physical asset. This simplifies the investment process, as you don’t need to worry about storage or transportation costs;
- Risk management: By investing in a commodity ETF, you can mitigate some of the risks associated with investing directly in futures contracts or derivatives. ETFs usually follow an index or a basket of commodities, allowing you to spread your risk across multiple assets;
- Lower Expense Ratios: Commodity ETFs generally have lower expense ratios compared to actively managed funds. This can result in cost savings for you as an investor.
How to invest in commodities ETFs safely?
When investing in commodity ETFs, bear in mind that they are subject to the usual risks associated with investing in any other ETFs, such as issuer risk, as well as the unique risks of their underlying assets. The price of commodities can be volatile and is influenced by factors like supply and demand, geopolitical events, and currency movements.
When it comes to creating an investment strategy for commodity ETFs, keep in mind the following factors as well:
- Tracking errors: Commodity ETFs attempt to replicate the performance of an underlying index or basket of commodities, but they may not always be successful. Sometimes, tracking errors occur when the ETF’s performance deviates from the target index, possibly due to factors such as management fees or the unique structure of the ETF;
- Contango and Backwardation: Commodity ETFs often invest in futures contracts. If the market is in contango — i.e., if futures prices are higher than spot prices –– the ETF might experience a negative roll yield as it rolls its contracts forward. This can lead to underperformance compared to the underlying commodity. On the other hand, backwardation occurs when futures contracts are priced lower than spot prices, which can positively impact the ETF’s performance;
- Volatility: Commodity prices can be highly volatile due to factors such as economic cycles, geopolitical events, and natural disasters. Consequently, investing in commodity ETFs can expose you to this volatility, potentially leading to fluctuations in the value of your investment;
- Leverage: Some commodity ETFs employ leverage to amplify their returns. While this might lead to higher gains in a favorable market, it also increases the risk and potential for losses during unfavorable market conditions.
In conclusion
In summary, commodity ETFs are a versatile and accessible way to invest in the world of commodities, offering exposure to a wide range of asset classes without the need to buy and store physical commodities or trade futures contracts. By including some commodity ETFs in your portfolio, you can potentially achieve better diversification and hedge against various market risks.
Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.
FAQs about commodity ETFs
What are commodity ETFs?
Commodity ETFs are financial instruments designed to track the performance of a specific commodity or a group of commodities, providing you with instant diversification and exposure to this market. There are various types of commodity ETFs, such as futures-based funds, equity funds, and physically-backed funds. Depending on your investment goals, strategies, and risk tolerance, you can invest in a wide variety of ETFs in a number of specific sectors, such as energy, precious metals, or agriculture.
What are the benefits of commodity ETFs?
By adding commodity ETFs into your investment strategy, you can increase your chances of potential future growth and diversify your portfolio to minimize risk during times of economic uncertainty. However, it is essential that you carefully research and evaluate each ETF you consider, as their performance can vary based on the underlying assets and the fund’s structure.
Where to invest in commodities ETFs?
Commodity ETFs are widely available on online brokerage platforms such as eToro.
How to trade commodity ETFs?
To buy and sell commodity ETFs, you can open a trading account at an online brokerage that lists commodity ETFs, such as eToro.
Why invest in ETFs instead of actual commodities?
ETFs are a useful financial instrument for investors who are looking for exposure to, for example, the agricultural industry without having to own and manage actual crops or livestock. In other words, ETFs are usually an affordable way to diversify your portfolio, create a hedge against inflation, and capitalize on the growth of various industries without having to manage physical assets.
What are the best commodity ETFs?
Determining the best commodity ETFs will largely depend on your risk tolerance and investment objectives. Many investors use precious metals ETFs like gold and silver to hedge against inflation.
