Commodity ETFs – Getting Started

When you combine the dynamic world of commodities with the rapidly growing universe of ETFs, things can get confusing very fast.

Here’s a simple framework to use when developing your strategy for using ETFs to gain exposure to commodities.

There are 4 basic buckets of commodities-related ETFs:

  • Broadly diversified fund
  • Single category fund
  • Single commodity fund
  • Blended commodity/equity fund

In the Broadly Diversified Fund, all commodities are represented giving the investor broad exposure to changes in changes in commodity prices with a single instrument. However, take a close look at how the fund is weighted.

If the fund is not equally-weighted, you could find yourself with an oil or gold fund in disguise. For example, although the $250 million iPath S&P GSCI Total Return Index ETN (NYSEArca: GSP) tracks an index that includes all major commodities, it is production-weighted to reflect each commodity’s relative significance to the world economy. As a result, GSP is 74% weighted towards energy. See the iPath website for more information on GSP.

A fund that is more evenly weighted will be better diversified against large movements of any single commodity. The $3.4 billion iPath Dow Jones-AIG Commodity Index Total Return ETN (NYSEArca: DJP) tracks an index that includes all major commodities and limits exposure to any one sector at 35%. The index is rebalanced annually. The iPath website has more information on DJP.

The 12 month chart below shows GSP outperforming DJP as the price of oil has run up to $120 a barrel. However, when oil eventually turns down, GSP will be more negatively impacted than DJP.

The Single Category Fund is one where a group of related commodities are represented. For example, the $2.3 billion PowerShares DB Agriculture Fund (Amex: DBA) tracks an index of futures contracts on a group of agriculture commodities including corn, wheat, soy beans and sugar. See the PowerShares website for more information on DBA.

A Single Commodity Fund provides exposure to only one commodity such as oil or gold. For example, the $19 billion StreetTracks Gold Fund (NYSEArca: GLD) provides a way to gain exposure to the price of gold bullion at a cost well below what you would pay to purchase, store and insure physical gold on your own. For more information on GLD, see the StreetTracks website.

A Blended Commodity/Equity Fund provides exposure to commodities through equities of companies whose fortunes are directly tied to commodities prices – oil services or mining companies for example. Equities tend to be more volatile than their associated underlying commodities as they are exposed to the additional risks of management performance and M&A activity.

An example of a blended fund is the SPDR S&P Metals & Mining ETF (NYSEArca: XME) which tracks an equal-weighted index of all companies traded on NYSE, AMEX and Nasdaq that are involved in the metals and mining industries. The fund is more heavily weighted towards materials (69%) than energy (31%). For more information on XME, see the SPDR website.

See our previous posts on commodity ETFs here and here.

For the more advanced commodities ETF investor, strategies such as options, shorting, inverse and ultra-inverse funds are also available.

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