How Reliable are Commodity ETFs?

Commodity Exchange-Traded Funds (Commodity ETFs) combine the reliability of an ETF with the complexities of a volatile commodities market. Therefore, the results of the fund typically show a hybrid effect, at times stable and low risk, at times very subject to market fluctuations. On the whole, though, a commodity ETF is a safer bet than investing directly into the commodity market. For this reason, it is a good entrance into the complexities of commodity investment.

What Is an ETF?

An ETF is essentially an open-ended fund that tracks a particular index or benchmark. When you buy shares of an ETF, you are buying shares of a fund that holds a list of underlying securities. As a result, you are essentially buying shares of those securities based on the percentage they each contribute to the fund's portfolio. An ETF trades on a daily basis on the exchange where it is listed. It trades at its Net Asset Value, which is the value of the whole of its underlying securities divided by the number of shares outstanding.

What Is a Commodity ETF?

A commodity ETF is specifically invested in the commodity market. This means the ETF holds options, futures and even bonds in the various levels of the commodity market. You can decide how much exposure you would like to more complicated derivatives by opting for a high-risk commodity ETF. You can also control the general profile you choose; for example, you may elect to invest in a hard commodity ETF, which trades mostly precious metals and natural resources. You may choose a soft commodity ETF, which trades crops and foodstuffs. The more specified your ETF, the more specified your results will be.

What Are the Benefits of a Commodity ETF?

The benefits of a commodity ETF are two-fold. First, you gain the ability to diversify your portfolio with a simple, single purchase, something offered by all ETFs. When you buy a share in the fund, you are buying a host of underlying assets, immediately diversifying your holdings to mitigate risks. A commodity ETF allows you to do this with commodities only. This is a great option if you would like to get into the commodities market but do not have the time or knowledge needed to invest in individual securities and contracts.

What Are the Risks of a Commodity ETF?

The commodity markets are some of the most volatile investment arenas. No matter how safe you think your funds are in an ETF, if that ETF specializes in commodities only, you are exposed to a host of unpredictable factors. For example, the price of oil can change drastically in a day in response to a political conflict. The price of orange juice can go through the roof if there is a deep freeze in the South. These items are not predictable or controllable. You can minimize exposure by choosing a broad ETF over one that is narrowly invested in one segment of the market. On the whole, the commodity option will still be less reliable than other ETF investments.

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