What Is a Commodity ETF?

A commodity ETF is an exchange-traded fund (ETF) invested in physical commodities, such as agricultural goods, natural resources, and precious metals. A commodity ETF is usually focused on either a single commodity—holding it in physical storage—or is focused on investments in futures contracts. Other commodity ETFs look to track the performance of a commodity index that includes dozens of individual commodities through a combination of physical storage and derivatives positions.

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An Introduction To Exchange-Traded Funds (ETFs)

Key Takeaways

  • A commodity ETF is an exchange-traded fund (ETF) that is invested in a variety of physical commodities, including natural resources, agricultural goods, and precious metals.
  • The commodity ETF focuses on either a single commodity or is focused on investments in futures contracts.
  • An investor that purchases a commodity ETF usually does not own a physical asset, but a set of contracts backed by the commodity.
  • Commodity ETFs are popular because they offer investors exposure to commodities without having to learn how to purchase futures or other types of derivative products. 
  • Popular types of commodities include precious metals, such as gold and silver, and oil and gas. 

How a Commodity ETF Works

ETFs usually consist of public equities that relate to a specific economy, market index, sector, or industry. Normal ETFs are made up of a collection of securities that are linked by a similar investment profile. Instead of underlying securities like public stocks, commodity ETFs are comprised of futures or asset-backed contracts that track the performance of a particular commodity or group of commodities.

When an investor purchases a commodity ETF, they normally do not own the physical asset but instead own a set of contracts backed by the commodity itself. Since many commodity ETFs use leverage through the purchase of derivative contracts, they may have large portions of uninvested cash, which is used to purchase Treasury securities or other nearly risk-free assets.

Commodity funds often create their own benchmark indexes that may include only agricultural products, natural resources or metals. As such, there is often tracking error around broader commodity indexes like the Dow Jones AIG Commodity Index. Even so, any commodity ETF should be passively invested in once the underlying index methodology is in place. Commodity ETFs have soared in popularity because they give investors exposure to commodities without requiring investors to learn how to purchase futures or other derivative products.

It pays to research commodity ETFs, researching the overall concept in great detail and watching the commodity ETF for a while to see how it progresses as the market changes. 

Example of a Commodity ETF

Commodity ETFs track a wide range of underlying commodities, some of which include precious metals, oil, and natural gas. Further, other commodity ETFs instead track a diversified basket of commodities. Investors should always do their own research, but some of the best commodity ETFs are precious metals like gold and silver. These are popular ETFs because the underlying commodity can't go bad or spoil. 

The SPDR Gold Shares (GLD) and iShares Silver Trust (SLV) are two of the largest gold and silver ETFs. The SPDR Gold Shares ETF has an expense ratio of 0.4%, and the iShares Silver Trust has an expense ratio of 0.5%.

Another popular type of commodity ETF is oil and natural gas. However, since oil and gas can't be stockpiled like precious metals, these ETFs invest in futures contracts instead of the commodity itself. The SPDR S&P Oil & Gas Exploration and Production ETF has a diversified portfolio of 60 oil- and gas-producing companies and has an annual expense ratio of 0.35%.

Some investors like to increase diversification through diversified commodities ETFs. These ETFs, such as the iShares MSCI Global Agriculture Producers ETF, tracks the United States Commodity Index.