Last year, investors demanded commodities and exchange traded funds (ETFs) became the go-to investment vehicle for tracking them. Investors should be aware of the the costs and risks involved when investing in commodity ETFs that track short-term futures contracts.
Commodities that are hard to store should show lower futures prices than spot prices, and the price of those futures should converge with spot prices as the expiration date comes, otherwise known as backwardation, writes Will McClatchy for ETFZone. The positive yield should disappear or go negative for easy to store commodities in which case futures may cost more than spot, otherwise known as contango. [What Contango Means for Oil ETFs.]
For all of their advantages, commodity ETFs can exhibit inefficiencies in some cases, like large funds buying up more than 5% of all market contracts, constant rolling over monthly contracts, predictable trade dates and short trading time-frames. [How to Harness Energy by Using ETFs.]
McClatchy suggests that ETF managers utilize some defensive techniques to avoid the trouble. He suggests expanding the roll window to multiple days or even weeks, expanding the list of securities, taking fewer physical deliveries and adopting disruptive trading tactics. Investors should note a commodity ETF’s performance against its benchmark and void large ETFs that deploy a simple, publicly disclosed trading strategy in small futures markets.
The bottom line remains, though, that commodity ETFs of all types have advantages particularly geared to the needs of the individual investor. They’re cheaper to use than futures contracts, there’s no need to roll anything over or take delivery, and it’s all in the transparent, tax-efficient format of an ETF. [The 4 Commodity ETF Types.]
For more information on commodities, visit our commodity category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.