Exchange-Traded Commodity (ETC): Definition, Meaning in Finance

What Is an Exchange-Traded Commodity (ETC)?

An exchange-traded commodity (ETC) is a type of security that can offer traders and investors without direct access to spot or derivatives commodities markets exposure to commodities such as metals, energy, and livestock. An ETC can track individual commodities or a basket of several commodities and can provide an interesting alternative to trading commodities in the futures market.

Understanding Exchange-Traded Commodities (ETCs)

ETCs are handy for investing in single markets such as livestock, precious or industrial metals, natural gas, and other commodities that are often difficult for individual investors to access. An example of a commodity basket ETC, on the other hand, is one that tracks multiple metals (not just one) or tracks a group of agricultural commodities, such as wheat, soybeans, and corn.

The performance of an ETC is connected to one of two sources. It might be based on the spot commodity price (the price for immediate delivery) or based on the futures price (a derivative contract for delivery at a future date). ETCs typically attempt to track the daily performance of the underlying commodity, but not necessarily long-term performance.

Just like other investment funds, ETCs charge a management fee, called the expense ratio, which compensates the company for running the ETC. In addition, every ETC has a net asset value (NAV), which is considered the fair value of each share based on the value of the holdings underlying the ETC. Since shares of the ETC trade on an exchange, its value on the market might fluctuate above or below the NAV value.

Exchange-Traded Commodities (ETCs) vs. Exchange-Traded Funds (ETFs)

ETCs allow investors to focus on a single commodity, whereas exchange-traded funds (ETFs) tend to invest more broadly over a wide variety of securities or companies.

Like ETFs, ETC shares are listed and traded on exchanges, with prices fluctuating based on price changes of the ETC's underlying commodities. However, unlike ETFs, ETCs are structured as notes, which are debt instruments underwritten by a bank for the issuer of the ETC, but which are backed by the commodities they track as collateral.

Thus, ETCs should not be confused with commodity ETFs, which invest directly in and hold physical commodities, such as agricultural goods, natural resources, and precious metals. The ETC doesn't buy or sell the commodity or futures contract directly. That note is collateralized by physical commodities, which are bought using the cash from inflows into the ETC.

Using assets as collateral reduces the risk if the underwriter of the note defaults. This is similar to an exchange-traded note (ETN), except that the ETC is collateralized by holdings in the physical commodity, whereas an ETN is not.

Types of Exchange-Traded Commodity (ETC)

Inverse ETCs are more complex instruments that move up when a commodity moves down, or vice versa.

Leveraged ETCs, meanwhile, are structured in such a way that commodity movements are multiplied by a particular factor, such as two or three, resulting in two or three times the volatility of the underlying commodity. Using leverage increases the potential for gains, but also potential losses.