Exchange traded funds invested in commodities offer investors access to a traditionally hard-to-reach market, but some commodity ETFs carry contango risks and aren't for everyone, says Michael Iachini, director of investment manager research at Charles Schwab Investment Advisory Inc.
The key, says Iachini in a Jan. 28 market insight on Schwab's "Research & Strategies" web page, is knowing whether an ETF tracks spot or futures prices. Futures-based ETFs, the most common structure for commodity ETFs, are subject to contango and backwardation, which can make a big impact on returns.
"An ETF that holds futures contracts is going to have worse returns than the physical commodity if the market remains in contango (and better returns if the market is in backwardation)," Iachini writes. "The risk with a futures-based ETF is that contango could erode returns."
Some ETFs hold the physical commodity itself, as is common with precious metals such as gold and silver, because storing the commodity is fairly straightforward, Iachini explains. Such ETFs will move with the spot price of the commodity, though the price could be affected by security issues around storing the physical commodity itself. Other ETFs hold baskets of futures contracts and never take possession of the physical commodity, which is the most common commodity ETF structure, whether for oil or agricultural commodities or sometimes precious metals.
