The Commodity Wave

Most physical commodity ETPs are limited to precious metals. Chief among these is the popular SPDR Gold Shares (GLD), whose share price reflects 1/10 the ounce price of gold bullion. GLD, like other bullion backed ETPs, holds its physical metal in secured vaults. 

The ETFS Physical PM Precious Metals Basket Shares (GLTR) takes a more diversified approach by holding gold, silver, platinum, and palladium together. GLTR's diversified approach can be a much smarter, especially for an advisor that wants to eliminate the guesswork of which precious metal will outperform. 

Currently, precious metals are taxed as collectibles and have a maximum long-term capital gain rate of 28%. Compared to equities, this puts them at a slight disadvantage. 

Other Factors

There are many important factors in deciding which commodities road to travel and taxes, of course, top the list.

Even with an expected and rising increase on long-term capital gains for equity investors, tax rates for commodity focused equity ETFs are still lower compared to the 28% tax on physically backed commodity ETPs like the SPDR Gold Shares (GLD) or the iShares Silver Trust (SLV). 

Another big factor is the type of product structure a commodity ETP uses.

For instance, ETNs, unlike ETFs or grantor trusts, carry an added dimension of credit risk. If that's not something you want your clients to have, then you should avoid using ETNs.

Also, the tax treatment for ETNs is different. Under current tax law, commodity and equity linked ETNs are taxed as prepaid contracts. This means investors incur tax consequences only upon the sale, redemption or maturity of their note. If held to maturity, the future payment of the contract is dependent on the value of the underlying securities or benchmark index. 

Finally, asset location is another crucial consideration. Where will the client hold the commodities? In a taxable or tax-deferred account? 

Generally speaking, commodity linked products that use futures contracts to obtain their market exposure are taxed at a 60/40 rate. Regardless of the holding period, 60% of gains are taxed at the long-term capital gains rate while the remaining 40% of gains are taxed as short term profits, which are subject to the investor's ordinary income tax rate. For investors in the highest tax bracket, this 60/40 split creates a maximum blended capital gains tax rate of 23%. The tax burden is reduced for investors in lower income brackets. 

Commodity equity ETFs are tax-efficient, so holding them in a taxable account makes good sense. On the other hand, futures based and physical commodity ETPs are less tax efficient, which means holding them in tax-deferred accounts can lessen the tax bite. 

Summary 

Although commodities are often misunderstood, they represent a big opportunity. If there's one asset class that individual investors probably lack exposure to—it's commodities. And that means investors may not be as diversified as they think. Why not see how many prospects or existing clients have adequate exposure to commodities?  

Helping your clients to add commodities using affordable and transparent ETPs is smart. Your approach —whether it's through equities, futures contracts, or physical commodities—will largely depend on your client's needs. But with your expertise, they are sure to make the right investment choices that leads them closer towards their goals.