Traditionally precious metals like gold and silver were the only commodities held by the common man. Till the advent of Commodity ETFs, an individual investor wanting to invest in any commodity had to either buy the physical commodity or buy commodity futures. Well, not any more. Today, you can buy gold, silver, oil or corn, by purchasing units of the respective Commodity ETFs.
Why Should A Retail Investor Invest In Commodities?
It is always better to invest in different asset classes. The reason is that the prices of different kinds of assets do not move in the same direction. For instance, prices of stocks and commodities often move in opposite directions. If you are exposed to stocks you will face huge losses in case of an economic downturn. If you hold investments in commodities too, their prices may rise at such a time and your losses will be reduced to that extent. So investment in commodities is more like a hedge to losses which may arise from other investments. However such an investment hedge may limit your profits too.
ETFs Invest In A Commodity In Any Of The Following Ways:
- Buy physical stock of the commodity as in the case of high value-low weight items like gold
- Buy commodity futures as in the case of low value-high weight items like industrial metals
- Hold part stock and part futures
How Are Commodity ETFs Better Than Commodity Futures?
- When you buy a commodity futures contract, you have to worry about ‘rolling over’ the position when the time for contract expiration draws close. Commodity ETFs pose no such problems. You can hold the ETF units you have purchased till whichever time you want to sell them.
- In the absence of Commodity ETFs, since a commodity investor had to keep selling and buying the commodity futures, he had to pay brokerage fees each time he bought and sold. But now, with the ETFs, all you have to do is buy the ETF units once and hold them till you sell. If you are a speculator, you can of courses trade in the ETFs as many times as you wish.
- When the only option of trading in commodities was through commodity futures, even an investor would unwittingly turn into a trader as he had to keep watching the prices for the purpose of ‘roll over’. As in stocks, keeping close tabs on the prices result in trading in the commodity instead of staying invested.
- The quantity to be purchased in case of commodity futures is very large and a retail investor cannot afford it. But in the case of commodity ETFs, the commodity can be purchased in small lots.
- The risk of investment in Commodity ETFs is less than the risk involved in commodity futures due to absence of leveraged trading.
Earlier, the commodity market was tapped only by large players because of the enormous investment and risks involved. Today individual investors can easily invest in commodities through Commodity ETFs without any of the hassles of trading in commodity futures.