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Revealed: The ins and outs of exchange traded commodities

by , 23 August 2013

Not only can you invest in shares or an index with exchange traded funds (ETF), you can also use them to invest in commodities. These types of ETF are very useful, but they do have their drawbacks. Let's take a closer look at exchange traded commodities…

Exchange traded funds (ETFs) are a very useful type of passive fund. They give you cheap access to almost any market you can think of.

Some ETFs offer what looks like an easy way to track the price of a certain commodity. And some of these products are extremely useful.

For example, you can get precious metals ETFs that track the price of gold or silver.

Many of these ETFs are physically backed by the metals themselves. So you know exactly what you’re getting.

These are a very handy way to track the price of gold or silver if you don’t fancy buying the physical metal yourself.

In SA, the only commodity based ETFs available to invest in are NewGold (gold backed) and NewPlat (platinum backed).

The trouble with some exchange traded commodities

However, other commodity-tracking ETFs offer to track the price of soft commodities like corn, or wheat, or an energy commodity like oil.

That might sound good to you. Perhaps you have a hunch that the oil price is about to tank. Or that corn prices will spike as climate change destroys crops in America’s Midwest. You might be tempted to put your hunch to the test by buying one of these products.

Stop. Here are a couple of simple questions to ask before you do so. Do you know what contango is? Do you know what backwardation is?

If not, then you shouldn’t touch these products with a ten-foot bargepole.

In short, the problem with these ETFs is that they don’t own the underlying commodities. That’s because while storing gold bars is pretty easy, storing barrels of oil or tonnes of grain isn’t.

So what they own is contracts giving them the right to buy these commodities within a certain timeframe. When the time runs out, the contract needs to be sold, and another bought (the contract is ‘rolled over’).

Usually, this costs the fund, and it can be quite a substantial cost. So even if the price of the commodity seems to be going up, you could easily lose money.

So unless you have an intimate understanding of the commodities futures market, then stick to physically-backed precious metals ETFs, like NewGold and NewPlat. These track the price reasonably accurately, so it’s easy to understand what they do.

Whether they will make you a profit or not is a different matter – but at least you can understand the bet that you’re making.

There you have it, the ins and outs of exchange traded commodities.

Revealed: The ins and outs of exchange traded commodities
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