Commodity ETF

Publication Date :

26 Mar, 2025

Blog Author :

Edited by :

Reviewed by :

Table of Contents

What Is A Commodity ETF?

Commodity ETF is an exchange-traded fund primarily involved in the domain of commodities like agricultural produce, natural resources, and metals. The purpose of this ETF is to enable traders to invest in multiple commodities without holding the physical asset, instead a set of contracts about the same asset.

The list of commodity ETFs belongs to a group of future or asset-backed contracts. They track the performance of commodities and reflect the same in the fund. However, in some cases, the fund may also invest in companies involved in commodities or invest directly in the commodity itself.

Key Takeaways

Commodity ETF is an investment fund that involves some popular commodities like agricultural products, natural resources, and metals as an underlying asset.
Instead of having ownership of that commodity, this ETF enables investment in them and gaining equivalent returns.
This ETF tracks the performance of the asset and reflects the same in the fund.
Common ETF-backed commodities include equity-backed funds, exchange-traded notes, and physically backed and futures-traded funds.
However, there is an equivalent risk in these ETFs that come with high volatility and high expense ratios compared to ETNs.

How Does A Commodity ETF Work?

Commodity ETF is a type of asset-backed fund that invests in different commodities, including agricultural resources, metals, and natural resources. They allow traders to take advantage of the ongoing volatility in commodities through this fund. Instead of holding physical assets, the trader receives an ETF contract here. On their behalf, the fund will hold the asset or gain exposure via futures contracts. For instance, if applicable, a person may buy an agricultural commodity ETF, where most of the holdings are in food grains like wheat, corn, soybean, or livestock. However, these ETFs can be highly liquid to act as an inflation hedge.

The largest commodity ETF group initiates the tracking of the commodity's performance. They follow a single or group of underlying commodities at every stage. At the same time, the ETF contracts reflect their performance and monitor it alongside. If a trader buys this ETF, the contract will showcase different commodities held beneath. During the course, if the price of corn or wheat fluctuates (or rises), the contract’s value will also behave the same.

With the negative correlation existing between stocks, bonds, and commodities, the exchange-traded funds soothe the entire route. They provide greater diversity with holdings and market conditions as well. However, when and who should invest in these ETFs is crucial. Since commodities provide a better tradeoff for the negative correlation, they act as a hedging instrument for the trader. Furthermore, this ETF provides a low-cost and easy option to invest against market volatility. Yet, in some commodities like oil, economic conditions like geopolitical relations with other nations may also cause more fluctuations.

Types

Commodity ETFs come in different types for investors. Depending on the risk tolerance level and investment needs, they can decide among these:

#1 - Equity ETFs

In equity-based funds, the holdings are in most of the publicly listed companies that trade, produce, or transport commodities. To be precise, their major business involves commodities, so this ETF intends to invest in such companies. Here, the portfolio will include multiple such companies to minimize risk and get associated with commodities. Also, they are relatively safer compared to other options.

#2 - Exchange-traded notes (ETNs)

As notes relate to debt securities, ETNs aim to provide returns linked to a specific commodity. The bank usually issues them with a maturity date. The prime advantage is that the trader receives no tax treatment unless the capital gains are realized. Also, to match the desired returns of a commodity, the ETN involves various strategies among stocks, bonds, and commodities.

#3 - Physically backed funds

As the name suggests, the commodities involved in physically backed funds involve physical assets instead of commodities. However, the allowance is only limited to precious metals. Apart from ownership, there is no asset tracking and counterparty risk. Yet, the major disadvantage over such ETFs is the cost of holding, delivery, storing, and insuring involved. Likewise, the tax treatment for the same depends on the capital gains realized. For instance, for short-term gains, the tax occurs at normal rates. Otherwise, it happens at the investor’s marginal rates.

#4 - Futures-based funds

This list of commodity ETFs involves futures contracts of the commodities traded. The portfolio includes futures, swaps, and forwards of the underlying assets. Since it involves no physical ownership of the asset, this ETF is free of cost. Here, most futures ETFs are limited partnerships that incorporate a roll-over strategy, where the futures contract gets replaced with another set of contracts when near expiry. For instance, the November month’s futures will replace the October month’s futures contracts.

Examples

Let us look at some examples of how the top commodity ETFs trade in real life:

Example #1

Suppose John is a trader dealing in commodities for almost a decade. He majorly traded in soybeans, corn, and gold. However, John found it tough to store them safely during this process. So, he decided to explore the futures-based ETFs, where he could invest in not just one but multiple commodities and have no physical holding cost involved. John bought corn futures and soybean futures. The advantage over here was that John was able to take price benefits from fluctuations in this agricultural commodity ETF. Also, a leverage base was created for him to profit from larger price movements.

Example #2

According to news published in August 2024, Bitcoin surpassed silver to become the largest commodity ETF traded in the United States. It occurred due to the propelled demand for Bitcoin stored as compared to the digital asset silver in terms of asset under management (AUM). Among all ETFs, Grayscale Bitcoin Trust ETF (GBTC) held around 619,000 bitcoins in the same month, whereas gold reported a combined AUM of $96.3 billion across various 19 ETFs.

Pros And Cons

Following are some of the advantages and disadvantages of holding and investing in commodity ETFs in general:

Pros	Cons
It provides access to multiple commodities under one umbrella.	Investments in commodities are highly volatile.
There is no physical ownership of assets required in most ETFs.	Exposure to futures-linked funds can carry a high risk of disrupting the returns.
It enables enough diversification to tackle inflation.	Certain ETFs involving commodities like metals may involve holding costs when taking physical ownership.
ETFs reflect real-time prices of commodities trading in the market.	At times, ETF returns may divert when tracking the asset’s performance.
These ETFs are low-cost investment vehicles with no holding or management costs involved.	Situations like contango can occur, where futures prices exceed spot prices, causing potential losses for traders.

Commodity ETF vs. Commodity ETN

Let us look at the pointers that explain the difference between commodity ETN and ETFs for a usual trader:

Aspects	Commodity ETF	Commodity ETN
1. Meaning	It refers to an exchange-traded fund where a commodity acts as an underlying asset.	Commodity exchange-traded notes are debt instruments dealing in commodities.
2. Underlying Assets	It includes both physical commodities and futures contracts in the same asset.	Here, futures contracts or a basket of commodities act as underlying assets for ETN.
3. Risk Exposure	There is higher volatility faced along with larger price movements.	There is credit risk involved when issued by the institution.
4. Fees	It involves higher expense ratios compared to ETNs.	It has lower expense ratios (fees).