Commodity ETFs give investors access to physical commodities like gold, silver, oil, and agricultural products without the hassle of storing physical goods or trading futures directly. In this guide, we will explain how commodity ETFs work, the different types available, and how to use them effectively in your portfolio.
What is a Commodity ETF?
A commodity ETF is an exchange-traded fund that tracks the price of one or more physical commodities. They provide exposure to raw materials and natural resources that are traded on global markets.
Why investors use commodity ETFs: Commodities often move differently than stocks and bonds, providing diversification. They can also serve as a hedge against inflation since commodity prices typically rise when the purchasing power of currency falls.
Types of Commodity ETFs
Physical Commodity ETFs
These ETFs actually hold the physical commodity in secure vaults:
- GLD: Holds physical gold bullion
- SLV: Holds physical silver bullion
- IAU: Physical gold (lower expense ratio than GLD)
- PPLT: Physical platinum
- PALL: Physical palladium
Physical ETFs track commodity prices closely because they own the actual metal. They are the simplest way to invest in precious metals.
Futures-Based Commodity ETFs
These ETFs hold futures contracts rather than physical commodities:
- USO: Crude oil futures
- UNG: Natural gas futures
- DBA: Agricultural commodities futures
- DBC: Diversified commodity futures
- PDBC: Broad commodity futures
Physical vs Futures ETFs
Key difference in how they work:
- Physical (GLD): Owns gold bars stored in vaults. Price tracks gold spot price closely.
- Futures (USO): Owns oil futures contracts that expire monthly. Must constantly sell expiring contracts and buy new ones (called "rolling").
This rolling process can cause futures-based ETFs to deviate from spot commodity prices over time.
Commodity Producer ETFs
These ETFs hold stocks of companies that produce commodities:
- GDX: Gold mining companies
- XLE: Oil and gas companies
- XME: Metals and mining companies
- MOO: Agricultural companies
Producer ETFs offer leverage to commodity prices since mining company profits increase significantly when commodity prices rise. However, they also carry stock market risk and company-specific risk.
Popular Commodity Categories
Precious Metals
Gold and silver are the most popular commodity ETF investments:
- Gold (GLD, IAU): Traditional safe-haven and inflation hedge
- Silver (SLV): More volatile than gold, industrial uses
- Platinum/Palladium: Industrial metals used in catalytic converters
Gold ETF tip: For long-term gold holdings, consider IAU over GLD. IAU has a 0.25% expense ratio compared to GLD's 0.40%, saving you money over time on identical gold exposure.
Energy
Oil and natural gas ETFs are popular but can be volatile:
- Crude oil (USO, BNO): Tracks oil prices through futures
- Natural gas (UNG): Very volatile, susceptible to contango
- Broad energy (XLE): Holds energy company stocks instead
Agriculture
Agricultural commodity ETFs cover crops and livestock:
- DBA: Diversified agriculture (corn, soybeans, wheat, etc.)
- CORN: Corn futures
- WEAT: Wheat futures
- SOYB: Soybean futures
Industrial Metals
Copper, aluminum, and other industrial metals:
- COPX: Copper mining companies
- DBB: Base metals (copper, aluminum, zinc)
- JJC: Copper futures
Understanding Contango and Backwardation
For futures-based commodity ETFs, these terms are crucial to understand:
Contango
When futures prices are higher than spot prices. As the ETF rolls from expiring contracts to new ones, it sells low and buys high, causing a drag on returns. This is common in oil and natural gas ETFs.
Backwardation
When futures prices are lower than spot prices. Rolling contracts generates positive returns as the ETF sells high and buys low. This is less common but can benefit investors.
Contango Example
Oil spot price: $70 per barrel
Next month futures: $72 per barrel
- USO must sell its expiring $70 contracts and buy $72 contracts
- This 2.8% loss happens every month the market is in contango
- Over a year, even if oil stays flat, USO could lose 10-20% to contango
This is why USO often underperforms actual oil prices over time.
Benefits of Commodity ETFs
1. Diversification
Commodities often move independently of stocks and bonds, reducing overall portfolio volatility.
2. Inflation Protection
Commodity prices typically rise with inflation, helping preserve purchasing power.
3. Easy Access
No need to store physical gold or trade complex futures contracts. Buy and sell like any stock.
4. Liquidity
Major commodity ETFs like GLD and USO trade millions of shares daily with tight spreads.
5. Portfolio Insurance
Gold in particular tends to rise during market stress, providing a hedge against stock market crashes.
Risks of Commodity ETFs
1. Contango Drag
Futures-based ETFs can significantly underperform spot commodity prices due to roll costs.
2. No Income
Unlike stocks (dividends) or bonds (interest), commodities do not generate income. You rely entirely on price appreciation.
3. Volatility
Commodity prices can swing dramatically based on supply disruptions, weather, geopolitical events, and currency movements.
4. Storage Costs
Physical commodity ETFs charge expense ratios that cover storage and insurance of the underlying metals.
5. Tax Complexity
Some commodity ETFs are structured as partnerships or grantor trusts, leading to complex tax reporting. Always consult a tax professional.
How to Use Commodity ETFs
Strategic Allocation
Many financial advisors recommend allocating 5-10% of a diversified portfolio to commodities:
- 2-5% in gold (GLD or IAU) for inflation protection
- 2-5% in diversified commodities (DBC or PDBC) for broader exposure
Tactical Trading
Traders use commodity ETFs to profit from short-term price movements based on:
- Supply and demand fundamentals
- Geopolitical events
- Weather patterns (for agriculture)
- Currency movements (commodities priced in dollars)
Inflation Hedge
Increase commodity allocation when inflation expectations rise. Gold and broad commodity ETFs can help protect purchasing power.
Track Your Commodity Positions
Pro Trader Dashboard helps you monitor your commodity ETF holdings alongside your stocks and bonds. See how commodities affect your overall portfolio diversification and performance.
Choosing the Right Commodity ETF
Consider these factors when selecting a commodity ETF:
- Structure: Physical (better for precious metals) vs futures-based (necessary for oil, gas, agriculture)
- Expense ratio: Compare similar ETFs and choose lower cost options
- Liquidity: Stick with heavily traded ETFs for tighter spreads
- Tracking: Research how well the ETF tracks its underlying commodity
- Tax implications: Some structures have better tax treatment than others
Summary
Commodity ETFs offer an accessible way to add diversification and inflation protection to your portfolio. Physical precious metal ETFs like GLD and IAU closely track their underlying commodities and work well for long-term holding. Futures-based ETFs for oil, gas, and agriculture are better suited for short-term tactical trades due to contango drag. A modest allocation of 5-10% to commodities can improve portfolio diversification, but understand the unique risks and costs before investing.
Want to explore more ways to diversify? Check out our guides on international ETFs or bond ETFs for other asset classes.