What is an ETF? -- Part 22: Commodities | ETF Trends

Exchange traded funds continue to increase in number and popularity, growing to one of the most commonly traded securities on the stock exchange as both institutional and the average retail investor gain greater access to broad or specialized market exposure. Yet many individuals are unfamiliar with ETFs’ inner workings. In this ongoing series, we hope to address your questions and help shed light on the investment vehicle. [What is an ETF? — Part 21: Preferred Stocks]

Before ETFs, trading in commodities was limited to investors with the time and money to carefully navigate a commodities broker account. Now, ETFs have democratized the way we trade commodities, providing the average retail investor the opportunity to gain exposure to various natural resources.

Commodities are negatively correlated with traditional stocks and bonds, serving as a portfolio diversifier – a negative correlation implies that there is a low relationship between the commodities and that of traditional assets. By allocating a small proportion of your wealth into commodities, you may be able to reduce overall portfolio volatility – if stocks and bonds underperform, commodities would help buoy the overall portfolio.

Some commodity ETFs may also provide equity-like returns, generating robust performances during economic booms when countries require basic materials to fuel growth. Unlike traditional financial assets, commodities are tied to macroeconomic conditions.

Moreover, commodities are also used as a hedge against inflation. By taking on exposure to commodities before inflation manifests, or in its earlier stages, an investor may retain purchasing power as prices rise up and the U.S. dollar depreciates.

To get the true diversification value of commodities, investors may consider futures-based or physically-backed commodity ETFs. Physically-backed ETFs eliminate the need to find storage and futures-based ETFs may make the ordinarily expensive and complicated world of futures investing more wallet-friendly and easier to follow.