Equities-Based ETFs
Equity-based commodity ETFs hold mining companies or other commodity producers. For some commodities, equity-based commodity ETFs may be the only way to gain exposure to these assets through an ETF.
While commodity producers may see profits rise if the commodity’s price rises, it should be noted that the performance of commodity producers does not always follow the spot price of their underlying commodity since firms will have a range of factors that could affect their performances. For example, mismanagement, corruption, environmental phenomenon, labor strikes and lawsuits could negatively affect a company; whereas, producers may also make new discoveries or streamline efficiency to help boost profitability.
What Affects Commodity ETFs
Commodity ETFs are subject to the basic laws of supply and demand in the underlying commodities market. Any changes in normal supply or demand would immediately affect spot prices. For instance, weather conditions, bureaucratic regulation, maintenance problems, or other global or domestic events that could lead to rapid shifts in the normal supply chain.
Commodities may also experience pricing trends depending on the season of the year. Agricultural products, such as livestock or crops, will produce higher or lower yields for different months of the year. Energy commodities will see prices peak during months of high energy usage, depending on the severity of weather conditions.
Current inventories help buffer prices in the event of supply shocks. If a commodity market were to suddenly experience a supply drop, inventories would be able to satisfy demand over the short-term. If supply remains depressed, inventories would run low, which would raise prices, and demand see a drop. As inventories drop below that of demand, the commodity may experience a temporary front-month spike in prices.
Foreign exchange rates also affect commodities. Since most commodities are priced in the U.S. dollar, appreciations or depreciations in the U.S. would have a large impact on commodity demand in foreign markets. As the U.S. dollar weakens, overseas buyers see a buying opportunity and horde the commodity.
Additionally, if inflation is expected to increase, farmers will raise crop prices by the same percentage to keep up with living costs. By investing in commodities, an investor is able to hedge against such price increases due to inflation.
Some commodities may potentially benefit from the world’s growing population and emerging middle class, since population growth has to be maintained by basic food supply and the world’s up-and-coming middle class will start demanding more protein-rich diets.
Overall, commodities tend to rise and fall along with the fortunes or misfortunes of the total economy. As an economy improves, people’s lives get better, and more basic commodities are consumed. This is particularly evident in heavy industries that depend on base metals in building materials.
Commodity ETFs can be a good portfolio diversifier. Commodities tend to be negatively correlated with traditional bonds and equities – there is a low linear relationship between commodities and traditional assets. Allocating a portion of one’s portfolio into futures-based or physically-backed commodities ETFs help reduce overall portfolio volatility.