Previously here at EEON, we’ve touched on how investors can utilize ETFs specifically developed to provide them with exposure to individual commodities in order to profit from a directional viewpoint on the commodity in question (The Goldbug Variations). Here, we’ll look at the scope of the options provided by commodity ETFs and discuss potential strategies for placing a directional bet.
Typically, commodity ETFs operate by focusing on a single commodity, like corn (CORN), coffee (JO), oil (OILK), or gold (GLD). While each individual commodity ETF differs in its strategy and approach to deploying invested capital, these funds typically invest in a set of contracts, called “futures”, that derive their value from the market value of the commodity in question. Futures contracts are agreements to buy or sell a predetermined amount of a given commodity at a specific price on a specific future date. As time progresses, the market value of the underlying commodity changes and the amount of time remaining before the predetermined date decreases, causing the value of the futures contract to correspondingly increase or decrease. Through this structure, commodity ETFs allow investors to place directional bets on the value of specific commodities without needing to learn how to buy and sell futures contracts independently.
Utilizing Long and Short Strategies
Investors that believe a specific commodity is going to increase in value in the future can do so by either purchasing shares in a “Long” commodity ETF, which would move in the same direction as the underlying commodity, or short selling shares in a “Short” commodity ETF, which would move in the opposite direction of the underlying commodity. For example, if an investor believed that the value of commoditized coffee was going to increase in the near term, they could purchase shares in the iPath Series B Bloomberg Coffee Subindex Total Return ETN (JO), which tracks an index that holds coffee futures contracts with varying maturities. If commoditized coffee prices increase, so does “JO”.
Alternatively, if an investor believed that the price of a widely traded commodity, like gold was going to increase, they could short-sell shares in a “Short” ETF, like Proshares Ultrashort Gold (GLL). This would allow them to profit from the decline in share price that would follow an increase in the price of the underlying commodity, in this case gold.
However, “Short” ETFs are typically utilized for placing bets that the value of the underlying commodity will decrease. Investors who believe that impending global developments will cause the value of a commodity like oil to decline can capitalize on their view by purchasing shares of a short oil ETF. For example, the chart below shows the share price of ProShares UltraShort Bloomberg Crude Oil (SCO), which invests in very short term, inverse (short) oil futures. The chart shows the value of SCO skyrocketing in spring of 2020 as oil prices collapsed due to geopolitical tensions and a price war between oil producers in Russia and Saudi Arabia. This incredible price movement highlights the value available to investors interpret how current events will impact commodities markets.
Commodity ETFs provide investors with easy access to investable assets that allow them to profit from the movement of specific commodities. The variety of available commodity ETFs is significant and allows investors to bet that the price of a given commodity will increase or decrease in the near, medium, or long term. Investing in commodity ETFs requires a heightened degree of diligence from investors, due to the volatile nature of the futures contracts that underlie each ETF. Investors should always read and understand a fund’s prospectus carefully before investing. However, investors who are willing to track ongoing global developments and interpret their likely impact on commodity markets stand to profit handsomely by investing in commodity ETFs that match their view of the future.