Commodities ETF: The Easier Way To Invest In The Commodity Segment

Every time you stopped at a filling station for gas or gone out to buy a precious gold ornament for someone, your heart must have felt the exponential rise in the commodity segment. In spite of stock trading in popular blue chip companies, the fact of the matter is that the commodity market brings with it a lot of opportunity to multiply your funds if you trade them with caution. Investing in commodities or commodity trading is very risky and should only be attempted if you know what you are doing. For those who had always wanted to invest in the commodity trade segment but were skeptical about timing the futures and options market correctly, the next best option is that of investing in a commodity ETF.

The commodity market as we know is actually a collection of 48 worldwide markets that trade 96 commodities. Everything from silver to orange juice concentrate can be sold. The largest market here in the United States is located in Chicago. Smaller in size and fame, the Chicago Mercantile Exchange or CME trades in a large amount of commodities.

Commodity ETFs come in several forms, but most were created to mirror the returns of commodities by investing in the commodity futures markets. They are all buy futures contracts based on the amount of funds they receive from investors. An excellent feature is that they trade just like a stock and you can buy or sell at any time during market hours. More importantly, you cannot lose more than your initial investment with an ETF, as many have this fear when they consider the futures markets. Because futures provide leverage (more exposure than the actual cash invested), ETFs that use futures contracts have uninvested cash, which they usually park in interest-bearing government bonds. The interest on the bonds is used to cover the expenses of the ETF and to pay dividends to the holders.

A number of commodity funds are actually structured as exchange-traded notes (ETNs) that are linked to futures-based commodity benchmarks. Commodity ETNs have both potential advantages and drawbacks. Because they don’t actually invest in futures contracts, ETNs will generally exhibit lower tracking error, and the management process may be more cost-efficient. But because ETNs are senior unsecured debt securities, they expose investors to the credit risk of the issuer. In the case of a bankruptcy, there are no underlying assets to be distributed to investors. Most ETN issuers maintain very high credit ratings, but the risk of default should never be completely written off.

ETFs and ETNs are however treated differently for taxation purposes. Current opinion is that all gains on ETNs held for longer than one year are treated as long-term capital gains, whereas an investor owning a futures-based ETF is taxed on any capital gains on the underlying futures held by the fund

Experts believe that the fast rate of industrialization in China and India and the integration of Russia and Eastern Europe into the global economy is going to boost the demand for commodities and drive the prices higher. Commodity trade investors are bullish that this trend would result in a long-term uptrend.

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