ETFdb Logo
ETFdb Logo
  • ETF Database
  • Channels
    • Themes
      • Active ETF
      • Artificial Intelligence
      • Beyond Basic Beta
      • China Insights
      • Climate Insights
      • Core Strategies
      • Crypto
      • Disruptive Technology
      • Energy Infrastructure
      • ETF Building Blocks
      • ETF Investing
      • ETF Education
      • ETF Strategist
      • Financial Literacy
      • Fixed Income
      • Free Cash Flow
      • Innovative ETFs
      • Institutional Income Strategies
      • Leveraged & Inverse
      • Managed Futures
      • Market Insights
      • Modern Alpha
      • Responsible Investing
      • Retirement Income
      • Tax Efficient Income
    • Asset Class
      • Equity
        • U.S. Equity
        • Int'l Developed
        • Emerging Market Equities
      • Alternatives
        • Commodities
        • Gold/Silver/Critical Minerals
        • Currency
        • Volatility
      • Fixed Income
        • Investment Grade Corporates
        • US Treasuries & TIPS
        • High Yield Corporates
        • Int'l Fixed Income
    • ETF Ecosystem
    • ETFs in Canada
    • Market Outlook Channel
  • Tools
    • ETF Screener
    • ETF Country Exposure Tool
    • ETF Sector Tracker Tool
    • ETF Database Categories
    • Head-To-Head ETF Comparison Tool
    • ETF Stock Exposure Tool
    • ETF Issuer Fund Flows
    • Indexes
    • Mutual Fund To ETF Converter
  • Research
    • ETF Education
    • Equity Investing
    • Dividend ETFs
    • Leveraged ETFs
    • Inverse ETFs
    • Index Education
    • Index Insights
    • Top ETF Sectors
    • Top ETF Issuers
    • Top ETF Industries
  • Webcasts
  • Themes
    • AI ETFs
    • Blockchain ETFs
    • See all Thematic Investing ETF themes
    • ESG Investing
    • Marijuana ETFs
  • Multimedia
    • ETF 360 Video Series
    • ETF of the Week Podcast
    • ETF Prime Podcast
    • Video
  • Company
    • About VettaFi
    • Get VettaFi’ed
  • PRO
    • Pro Content
    • Pro Tools
    • Advanced
    • FAQ
    • Pricing
    • Free Sign Up
    • Login
  1. ETF Investing
  2. Why Commodity ETPs Deviate From Spot Price
ETF Investing
Share

Why Commodity ETPs Deviate From Spot Price

Stoyan BojinovApr 20, 2016
2016-04-20

Commodity exchange-traded products (ETPs) have raised some eyebrows over the years because their returns don’t always line up with the respective spot prices they are designed to track.

Below, ETF Database takes a look at the various types of exchange-traded commodity investment vehicles and why their returns don’t always line up with spot prices as one might expect.

The Basics Behind Commodity ETPs

The Appeal

Commodity ETPs have opened up the doors to an asset class historically respected for its diversification and inflation-fighting benefits among investors. Indeed, traders too have embraced these vehicles for their easy access to a variety of once hard-to-reach corners of the market.


Content continues below advertisement

How They Work

When all is said and done, these investment vehicles are able to accomplish all of the above feats in one of two ways. First, they may do so by providing futures-based exposure to the said natural resource. For example, a futures-based oil fund would consist of crude oil futures contracts; in other words, a futures-based ETP takes care of the futures-related nuances and upkeep so you don’t have to.

These types of commodity ETPs do bear a few noteworthy nuances which are discussed in greater detail below.

Second, these investment vehicles may actually buy and hold the said resource, thereby providing physically backed exposure. Obviously, this type of approach clearly does not lend itself to most of the commodities market, as many resources are perishable and just outright difficult (and expensive) to store. The thought of a physically backed energy (or grains) ETF that hoards barrels of crude oil (or bushels of corn) in existence is laughable.

With that said, while physically backed exposure may be out of the question for most commodities, this strategy is highly sought after in the case of precious metals. The key benefit of this approach is that these products tend to exhibit near-perfect correlation with spot prices. Again, an inherent downfall here is the fact that this approach does not lend itself to practically any other commodity family.

Nuances to Consider

There are number of reasons why futures-based commodity ETPs will not move in perfect unison with spot prices, namely:

  • Outside of the ETF scope, commodity futures prices are by nature not exactly the same as spot because they are just contracts and thereby instruments themselves after all. In other words, without even getting into the complexities of managing a futures-based fund, futures are inherently going to lack perfect correlation with spot. Some of the variables that affect futures prices include interest rates, carrying costs, income yield and storage costs.
  • Constructing a portfolio out of futures contracts, in lieu of obtaining physically backed exposure, leaves the fund susceptible to four factors:
  1. Changes in the futures contracts prices themselves, be it gold or oil contracts fluctuating in value.
  2. Uninvested cash in the portfolio.
  3. The cost, known as “roll yield”, that is incurred when front-month contracts are swapped for longer-dated ones to keep the portfolio’s exposure in line with spot as best as possible.
  4. Contango, which refers to the situation when longer-dated futures contracts are more expensive than those that are closest to expiration. This means that ETPs which hold only front-month futures will be forced to sell low and buy high come portfolio rebalancing time.

For these reasons, investors simply cannot expect futures-based commodity ETPs to perfectly correlate with spot prices, and especially so over the long haul.

There are some “remedies” however, including the proliferation of so-called third-generation commodity products, made popular by firms like Teucrium, which are built to reduce the negative impact of contango by taking a more balanced/proactive approach when it comes to selecting the contracts they hold.

Commodity ETPs vs. Spot Price Returns

Let’s consider some real-life examples of how well futures and physically backed products track commodity spot prices.

One-year daily returns as of 4/19/2016.

Oil ETPs

oil etfs vs spot crude oil

The worst tracker has been the front-month-based fund (USO B), whereas the best tracker has been (USL B+), which is based on the average price of 12 futures contracts on crude. Stuck in the middle, albeit much closer to the best tracker, is (OLEM C+), which may roll its exposure into contracts with varying expiration dates in lieu of a pre-determined roll schedule.

The key takeaway here is that front-month-based products may come with more nuances than others, and because commodity ETPs are already imperfect tracking tools to begin with, this leaves even more room for divergence from spot prices.

Gold ETPs

gold etfs vs spot gold price

The best tracker in this case is the physically backed (GLD A-), which has offered more precise exposure to gold prices than its ETN, futures-based brethren (DGL A). While the divergence in this case is not as drastic as the oil comparison above, this is still notable, and especially so for longer-term investors.

Ways to Play

Investors can pick their commodity ETP based on exposure type:

  • Futures-Based.
  • Physically Backed.

Alternatively, they can also navigate the investable commodity ETP universe by resource type:

  • Broad-Based.
  • Agriculture.
  • Energy.
  • Industrial Metals.
  • Precious Metals.
  • Livestock.
  • Softs.

The Bottom Line

Commodity ETPs can be utilized in a variety of ways, ranging from portfolio building blocks to tactical trading instruments. Investors should, however, be well aware of the inherent nuances, and by many measures, drawbacks, associated with some of the futures-based products on the market. Be sure to do your homework on any product, be it front- or multi-month contract-based, futures or physically backed, before pulling the trigger.

Follow me @SBojinov

» Popular Pages

  • Tickers
  • Articles

Dec 05

ALPS’ Disruptive Technologies ETF Outpaced Broad Tech Sector in November

Dec 05

Invesco’s S&P 500 Equal Weight ETF Nears $10 Billion in YTD Flows

Dec 05

Top Performing Leveraged/Inverse ETFs: 12/03/2023

Dec 05

Notes From the Desk: Fedspeak Lifts Markets

Dec 05

In Times of Market Stress, DBMF Delivered Smoother Ride

Dec 05

BMO Launches MAX S&P 500 4X Leveraged ETNs on the NYSE

Dec 05

Market Valuation, Inflation and Treasury Yields: November 2023

Dec 05

2 Factors Sparking Bitcoin Surge

Dec 05

As Yields Fall, Diversify Income With These 2 ETFs

Dec 05

China Stocks Could Enter Bull Market in 2024

QQQ

Invesco QQQ Trust Series I

SPY

SPDR S&P 500 ETF Trust

VOO

Vanguard S&P 500 ETF

VGT

Vanguard Information...

SCHD

Schwab US Dividend Equity ETF...

XLK

Technology Select Sector SPDR...

SMH

VanEck Semiconductor ETF

IYW

iShares U.S. Technology ETF

VTI

Vanguard Total Stock Market...

IVV

iShares Core S&P 500 ETF

Loading Articles...
Our Sites
  • VettaFi
  • Advisor Perspectives
  • ETF Trends
Tools
  • ETF Screener
  • Mutual Fund to ETF Converter
  • Head-To-Head ETF Comparison
  • ETF Country Exposure Tool
  • ETF Stock Exposure Tool
  • ETF Database Pro
More Tools
  • Financial Advisor & RIA Center
Explore ETFs
  • ETF News
  • ETF Category Reports
  • Premium Articles
  • Alphabetical Listing of ETFs
  • Browse ETFs by ETF Database Category
  • Browse ETFs by Index
  • Browse ETFs by Issuer
  • Compare ETFs
Information
  • Contact Us
  • Terms of Use and Privacy Policy
  • © 2023 VettaFi LLC. All rights reserved.

Advertisement

Is Your Portfolio Positioned With Enough Global Exposure?

ETF Education Channel

How to Allocate Commodities in Portfolios

Tom LydonApr 26, 2022
2022-04-26

A long-running debate in asset allocation circles is how much of a portfolio an investor should...

Core Strategies Channel

Why ETFs Experience Limit Up/Down Protections

Karrie GordonMay 13, 2022
2022-05-13

In a digital age where information moves in milliseconds and millions of participants can transact...

}
X