Last week, we discussed physically backed ETFs, which are just as the name implies: each share is backed by a physical product. Right now, physically backed ETFs only give exposure to precious metals. You won’t find an ETF backed by barrels of oil or livestock. [4 Types of Commodity ETFs.]

Physically backed ETFs have a special appeal to smaller investors who either lack the space for storage, or the inclination to hunt down and pay for storage themselves. In ETFs backed by physical metals, all you need to do is show up and buy a share. The rest is taken care of for you. [Contango and What You Can Do About It.]

These ETFs tend to correlate more closely to the spot price than commodity funds that hold equities or futures. The taxes are a bit different, too: profits in bullion-based ETFs are taxed at 28% (but consult your personal tax professional for specific advice). [ETFs and Taxes: What You Should Know.]

Physically backed commodity ETFs also enjoy the other benefits of ETFs, including cost-efficiency, tax efficiency and transparency (the bullion holdings in these funds are subject to regular audits and the results are posted on the ETF provider’s website).

For more stories about commodity ETFs, visit our commodity ETFs category.

• SPDR Gold Trust (NYSEArca: GLD)
• ETFS Physical Platinum (NYSEArca: PPLT)
• iShare COMEX Gold Trust (NYSEArca: IAU)
• ETFS Physical Palladium (NYSEArca: PALL)
• iShares Silver Trust (NYSEArca: SLV)
• ETFS Silver Shares (NYSEArca: SIVR)
• ETFS Gold Shares (NYSEArca: SGOL)

One of the most popular commodity ETF types are those that hold and trade futures contracts for the underlying commodity. Futures are a promise to buy or sell a commodity for a set price on a date that’s in the near future. None of the ETFs that hold futures contracts claim to track the spot price of their respective commodities. [4 Commodity ETF Types.]

The majority of these funds buy the near-month contract, selling it before expiration and buying the next month’s contract, and so on. If the price of the next month’s contract is higher than the current month’s, it’s a situation called contango, and it could cost you money when the contracts are rolled over. A negative roll yield (contango) could cause the net asset value (NAV) of a fund to deviate even further from the spot price of its underlying commodity. The opposite situation is backwardation. [What Contango Means for Oil ETFs.]

One way to mitigate the effects of contango is to look for ETFs that hold contracts throughout the year. There are just two such funds now: United States 12-Month Oil (NYSEArca: USL) and United States 12-Month Natural Gas (NYSEArca: UNL).

The purpose of a 12-month strategy will help protect futures investors from the problem of contango. Two weeks before the expiration of the nearest-month contract, the fund will roll forward another month, picking up the then-12-months-out contract.

Other examples of futures-based ETFs include: United States Natural Gas (NYSEArca: UNG), PowerShares DB Gold (NYSEArca: DGL) and iShares S&P GSCI Commodity-Indexed Trust (NYSEArca: GSG). [Risks and rewards of futures-based ETFs.]

For more information on ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

John Dimsdale for Marketplace Public Radio reports Obama is unveiling a proposal for coal-burning power plants to switch to natural gas. That’s because natural gas is cleaner, and the United States has got it in spades. Big oil might like the proposal, too, as many companies have made significant investments into natural gas. The trade-off? Coal is still cheaper than gas, and coal means lots of jobs for economically-depressed parts of the country, like Appalachia. [Harnessing Energy With ETFs.]

Jason Womack for The Wall Street Journal reports that natural gas futures are moving higher as a low pressure system moves in to the Eastern part of the United States, meaning that there’s more heating demand. On the other hand, winter is beginning to wind down and natural gas reserves are high, so it will be interesting to watch how this plays out. [Why Commodity ETFs Underperformed Spot Markets.]

Natural gas in U.S. storage for the week ended Feb. 12 stood at 2.025 trillion cubic feet; 1.3% higher than last year and 2.7% above the five-year average, according to the U.S. Energy Information Administration. [The Four Types of Commodity ETFs.]

For more stories about natural gas, visit our natural gas category.

• United States 12 Month Natural Gas (NYSEArca: UNL)

• United States Natural Gas (NYSEArca: UNG)

• First Trust ISE Revere Natural Gas (NYSEArca: FCG)

• iPath DJ UBS Natural Gas Total Return Sub-Index (NYSEArca: GAZ)

For most precious metals ETFs, the ETF will likely hold the physical commodity, but in many cases, a commodity ETF just holds future contracts or notes redeemable by a bank, remarks Kurt Brouwer for MarketWatch. By investing in futures contracts and other so-called derivatives, commodity ETFs may diverge from the actual commodity they are tracking. [Why Commodity ETFs Underperformed Spot Markets.]

For example, United States Natural Gas (NYSEArca: UNG) plummeted around 50% in 2009 while natural gas prices only dropped around 12%. PowerShares DB Oil (NYSEArca: DBO) has gained 16% since its inception in 2007, but oil prices have jumped about 40%.

The world of commodity ETFs was shaken as regulators talked about imposing position limits on the funds, according to The Motley Fool. Commodity ETF traders suspected that some may have been exploiting the funds’ predictability of always investing in the next month’s futures contracts in which the traders would push up contract prices just before funds “roll-over” them. [CFTC's ETF Proposal.]

Commodities are still a good way to diversify an otherwise bland portfolio, but before you invest, assess your risk tolerance and act accordingly:

• If you don’t mind taking risks, narrowly focused commodity funds can give you more pure exposure to a particular commodity. With that single-commodity exposure comes more potential for volatility, though.
• If you want more safety, check out broad commodity funds that give you exposure to a diversified basket of commodities. The downside is that you won’t fully capitalize if any one commodity is performing particularly well.
• Utilize a strategy when investing in commodities. A simple one we suggest is trend following, which you can read about here.

For more information on commodities, visit our commodity category.

• iShares GSCI Commodity Indexed Trust (NYSEArca: GSG)
• PowerShares DB Commodity Index (NYSEArca: DBC)
• Greenhaven Continuous Commodity (NYSEArca: GCC)
• iPath Dow Jones-AIG Commodity Index Fund ETN (NYSEArca: DJP)
• PowerShares DB Agricultural Fund (NYSEArca: DBA)
• Market Vectors RVE Hard Assets Producers (NYSEArca: HAP)
• PowerShares DB Energy Fund (NYSEArca: DBE)
• PowerShares DB Base Metals (NYSEArca: DBB)
• ELEMENTS S&P CTI ETN (NYSEArca: LSC)

Max Chen contributed to this article.

Big western oil companies are trying to sustain reserves by expanding through acquisitions and investment, according to The Economist. For instance, Exxon Mobil (NYSE: XOM) estimated that exploration and capital spending hit $27.1 billion in 2009, or 4% higher than in 2008. The company also expects to continue spending around $25 billion to $30 billion a year over the next five years for the same purpose.

• iShares Dow Jones U.S. Oil and Gas Exploration (NYSEArca:IEO)
• SPDR S&P Oil & Gas Exploration & Production (NYSEArca: XOP)
• PowerShares Dynamic Oil & Gas Services (NYSEArca: PXJ)
• Energy Select Sector SPDR (NYSEArca: XLE)

Western oil companies are finding fewer new big oil fields that are easy to reach and cheap to exploit. Consequently, firms are being forced to look for other areas of growth, which include hard-to-reach areas like deep offshore, tar sand and shale bed reserves. [Will Oil Prices Stick?]

• United States Oil (NYSEArca: USO)
• PowerShares DB Oil (NYSEArca: DBO)

Additionally, companies are branching out to other energy reserves. France’s Total is looking into nuclear-energy and Royal Dutch Shell (NYSE: RDS-B) has announced a $12 billion joint-venture with Cosan, Brazilian producer of ethanol. Exxon and Shell are also both investing in “second generation” biofuels, but it may take years to develop.

• Market Vectors Nuclear Energy (NYSEArca: NLR)

Oil companies have also put a lot of money into natural gas. Around 40% of Shell’s total production is in the form of gas. With the expected growth in th global market for gas by half by 2030, gas is becoming more and more important for power generation and heating.

• United States Natural Gas (NYSEArca: UNG)
• United States 12-Month Natural Gas (NYSEArca: UNL)
• First Trust Natural Gas Fund (NYSEArca: FCG)

Meanwhile, oil’s future is uncertain. While the price is more than double what it was at its lowest point last year, the rally has been driven primarily by optimism and earnings reports. There’s a battle coming, says Kevin Grewal for The Street. Absolute inventory volumes of crude oil are expected to stay well above the levels they were at one year ago. If production levels stay the same or increase, we could be looking at a global surplus.

For more information on energy sector, visit our energy category.

Max Chen contributed to this article.

Health Care. The vote to fill the seat of late Sen. Edward M. Kennedy shifted power in the Senate. Scott Brown won the race against Democrat Martha Coakley 52% to 47%, costing Democrats their 60-vote majority. Brown has been an opponent of health care legislation, and many fear it’s a death knell for the effort. [Massachusetts race.] The health care bill would bring in more patient business to hospitals if it were to pass legislation. But Obama is not giving up, and appealed to lawmakers to “take another look at the plan we’ve proposed” and not to walk away from reform.

• iShares Dow Jones U.S. Health Care Sector (NYSEArca: IYH)

• Vanguard Health Care (NYSEArca: VHT)

• Health Care Select Sector (NYSEArca: XLV)

Regional Banks. Obama is pushing to limit the size of the nation’s largest banks, although he limited the amount of time spent on this aspect of the economy last night. Smaller banks won’t face the regulations and restrictions the big banks might, giving them more appeal than ever. Banks that stuck to their traditional business models throughout the crisis are already demonstrating their health through strong earnings. Regional banks do need some caution, though, because a high unemployment late could lead to more consumer default on credit lines. [Why regional banks could come out ahead.]

• SPDR KBW Regional Banking (NYSEArca: KRE)
  



• Regional Bank HOLDRs (NYSEArca: RKH): USB is 17.5%

• iShares Dow Jones U.S. Regional Banks (NYSEArca: IAT)

Energy. Oil futures are up today following the State of the Union address, thanks to the sense of optimism about both the domestic and global economy that some feel the speech gave. As the world stabilizes, demand for fuel is expected to once again rise. The Commodity Futures Trading Commission (CFTC) has released a few proposals on commodity investments. The CFTC cited United States Natural Gas (NYSEArca: UNG) and United States Oil (NYSEArca: USO) as examples for the new “Proposed Position Limit Rule.” The CFTC has called for tighter rules on energy trading and stricter definitions of traders who are exempt. [The CFTC's new proposal.]

• United States Natural Gas (NYSEArca: UNG)

• United States Oil (NYSEArca: USO)

Green Energy. It’s no secret that Obama is firmly on the side of fixing climate change. In last night’s speech, he specifically called for more “safe, clean” nuclear plants. He also reiterated his call for developing solar cells, clean coal, biofuels and rebates for Americans who boost their homes’ energy efficiency.  [Socially responsible ETFs gaining in popularity.]

• PowerShares Global Clean Energy (NYSEArca: PBD)

• First Trust NASDAQ Clean Edge Green Energy (NYSEArca: QCLN)
  

• Market Vectors Nuclear Energy (NYSEArca: NLR)

• Claymore/MAC Global Solar Energy (NYSEArca: TAN)

Our economy. Despite huge rallies in the stock markets, Treasuries are still in high demand as a safe haven. Bonds serve to reduce volatility in a portfolio while generating income – the quarterly, semi-annual or annual fixed income is generally more than dividend payments from stocks. [What's the deal with bond ETFs?] Obama also said he wanted to see exports double in the next five years, as well as tax cuts that would put more cash in the hands of small business owners.

• iShares Barclays 7-10 Year Treasury Fund (NYSEArca: IEI)

• iShares Russell 2000 Index (NYSEArca: IWM)

• SPDRs (NYSEArca: SPY)

Inflation? The Federal Reserve yesterday said that inflation is expected to remain low for the time being, and Obama didn’t address the issue much in his speech, choosing to focus on job creation. With practically every country in the world rolling out billions to ease the burdens of the financial crisis, the possibility of high inflation has a lot of people seeking a safe haven in gold. Furthermore, many countries are not yet in good fiscal health, the United States included. Additional sovereign-debt downgrades from ratings agencies are but one potential trigger of a currency crisis, which could make gold an appealing store of value. [Reasons gold may still have life left.]

• SPDR Gold Shares (NYSEArca: GLD)

Max Chen contributed to this article.

The CFTC cited United States Natural Gas (NYSEArca: UNG) and United States Oil (NYSEArca: USO) as examples for the new “Proposed Position Limit Rule,” writes Don Dion for TheStreet. The proposal covers four energy commodities: Henry Hub natural gas, light, sweet crude oil prices, New York Harbor No. 2 heating oil and New York Harbor gasoline blendstock. Additionally, the regulation will affect the New York Mercantile Exchange and the Intercontinental Exchange. [Will regulation hurt the ETF industry?]

The proposal offers up a formula that can be used to calculate the number of futures contracts any single fund can hold.

In recent months, the CFTC has been monitoring certain ETFs and their impact on the price of the underlying commodities. UNG and USO offer investors exposure to the prices of natural gas and oil, respectively, by tracking near-month futures contracts. The CFTC has called for tighter rules on energy trading and stricter definitions of traders who are exempt.

United States Commodity Funds, the provider behind the funds, has vigorously defended their funds and refuted claims that they were responsible for wild energy price swings. [CFTC and commodity ETF provider face off.]

ETF managers have begun selling off future positions and creating shares through the use of swaps in an attempt to obviate the troubles associated with position limits. However, the CFTC is asking Congress for the authority to regulate over-the-counter markets, which include bilateral swaps. [CFTC actions prompt fee hikes.]

Still, ETFs such as the United States 12-Month Natural Gas (NYSEArca: UNL) will go on as normal, since it does not rely on near-month futures contracts. UNG tracks the average prices of 12 futures contracts on natural gas that are made up of near-month contracts set to expire and the contracts for the following 11-months.

For more information on commodities, visit our commodity category.

• United States Natural Gas (NYSEArca: UNG)

• United States Oil (NYSEArca: USO)

• United States 12-Month Natural Gas (NYSEArca: UNL)

Max Chen contributed to this article.

According to Paul Justice, a Morningstar analyst, commodity ETFs lagged behind spot markets and equity ETFs that held oil, gas and agricultural companies companies in 2009, reports Asjylyn Loder for Bloomberg. For instance, the United States Natural Gas (NYSEArca: UNG) dropped around 50% while the First Trust ISE-Revere Natural Gas (NYSEArca: FCG), which invests in natural gas companies, increased around 50%. PowerShares DB Commodity Index Fund (NYSEArca: DBC), saw gains of around 16% in 2009, but iShares S&P North American Natural Resources Sector (NYSEArca: IGE) had a total return of around 37%.

The National Stock Exchange, an electronic exchange for U.S.-listed stocks and ETFs, reported that commodity share growth in the total U.S. ETF market increased to 9.3% from 4.6%. In 2009 alone, more than $30 billion found its way into commodity products, which was more than a quarter of all U.S. ETF inflows.

Dave Nadig, director of research for IndexUniverse, believes investors are looking into commodities because of rising demand for raw materials in countries like China, India and Brazil.

Nadig explains that some funds like natural gas, oil and wheat are still suffering through contango – when a longer-dated contract is more expensive than the one the ETF needs to sell before the expiration date, which forces the fund to pay more each month to keep its same exposure levels.

For example, crude prices increased 78% last year, but United States Oil (NYSEArca: USO) only gained around 19%, while iShares Dow Jones U.S. Oil and Gas Exploration (NYSEArca:IEO) gained around 41% and SPDR S&P Oil & Gas Exploration & Production (NYSEArca: XOP) returned around 40%. Satch Chada, managing director at Jefferies Asset Management LLC, says that funds that hold commodity companies may be benefiting from contango due to the markets predicting high future prices.

Commodity ETFs provide a pure play bet and an ETF that holds company stocks put investors in a situation where the profitability of the underlying company is a factor.

For more information on commodities, visit our commodity category.

Max Chen contributed to this article.

Every investor needs to study up on ETFs before actually investing in them, remarks John Spence for MarketWatch. This research is crucial step that many investors have ignored, burning them in the process. [Benefits of ETFs.]

For instance, United States Natural Gas (NYSEArca: UNG) dropped more than 50% last year, but investors still put money into the fund in an attempt to time a bottom to natural gas prices. According to Morningstar, investors may have lost $1.5 billion betting on the ETF. Additionally, the ETF lost money rolling futures as a result of “contango,” and the fund also has a tax structure like a limited partnership. [More on UNG.]

Nicholas Colas, ConvergEx Group chief market strategists, stresses the need to  look at an ETF’s “portfolio construction, re-weightings, management fees or index being tracked.” Different ETFs have varying sector weightings – some ETFs that track similar things may even have sector weightings that are completely disparate. Furthermore, some ETFs have high weightings in their top holdings, so be sure to look at what makes up the fund and be sure you are comfortable with it. [Know your ETF holdings.]

For more information on ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

A higher-than-expected supply of natural gas could get used up as downright Arctic weather settles over much of the United States. Could this be the boost that United States Natural Gas (NYSEArca: UNG) needs? [Will the commodity ETFS make a comeback?]

Don Dion for The Street explains that regulators are seeking to rein in “excess speculation” with futures position limits, which could have an impact on UNG. The regulations haven’t yet fully materialized, but UNG’s managers restructured the fund last summer in anticipation. [Natural gas ETF turns to swaps.]

Jeffry Harris, chief economist at the Commodity Futures Trading Commission (CFTC), claimed that he could find a connection between speculation and high energy prices, although United States Commodity Funds Chief Investment Officer John Hyland vigorously defended the funds, calling those claims ’self-serving statistical gibberish.” [CFTC and commodity ETF provider face off.]

As he prepares to return to academia, CFTC Chairman Gary Gensler – who believes that the American public should be protected from excessive speculation – will be able to appoint Harris’ successor. [The commodity regulators are making forward progress.]

For the time  being, UNG and other commodity-focused ETFs have come up with ways to get around the scrutiny by restructuring the ETFs while still ensuring the funds stick close to their goals.

Investors skittish about the upcoming regulations may want to examine commodity ETFs that hold equities, such as the First Trust ISE-Revere Natural Gas (NYSEArca: FCG), which doesn’t hold futures or swaps. FCG is up 15.4% in the last month, while UNG is up 23.2% in the last month.

For more stories about natural gas, visit our natural gas category.