How Do Commodity ETFs Work?

The performance of the commodity will determine the value of the contract at the time it is bought and sold. ETFs investing in commodities typically use leverage, which is borrowed capital.

By using leverage, the commodity ETF has excess cash to invest in risk-free assets like Treasury bills as a hedge against the contracts. This protects the fund and its investors in the event of a downturn in that respective commodity market.

How Commodity ETFs Perform

The commodity ETF will typically create its own benchmark index to track the performance of the fund. Depending on the ETF, these commodities can track precious metals, energy or whatever commodity comprises the fund focus.

The performance of that proprietary index created by the fund will determine its performance. Since the performance is tied to an index, one thing to take note of is that tracking error could result in a commodity ETF–the price difference between an investment and that of the index.

Examples of Commodity ETFs:

For more educational information on ETFs, click here for Education Central.