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Investing in Commodities with ETFs
Slide 2: Investing in Commodities with ETFs
When thinking about asset allocation, most investors have considered the pros and cons of cash, stocks, and bonds. But one area that can go overlooked is commodities. Investing in tangible assets like oil, gold, silver, corn, and soybeans can offer diversification benefits that can traditionally be reaped when other securities markets are performing poorly. Commodities can also provide some protection from inflation.
Slide 3: Investing in Commodities with ETFs
Despite these potential benefits, there are several important downsides to consider. Unlike stocks and bonds, commodities don't produce income or have a stake in future profits of a business. They are worth what other investors are willing to pay for them. And long-term returns on commodities have not been outstanding. Morningstar research has shown that for most investors, direct commodity exposure should very limited and diversified among energy, agricultural, and industrial and precious metals.
Slide 4: Investing in Commodities with ETFs
But how do you invest in commodities? Although you could physically buy gold bars or barrels of oil and keep them in your garage, this is not a practical solution. You have to worry about insurance and storage, and some soft commodities like corn aren't going to hold up too well over the years. For decades, these limitations meant that individual investors were essentially locked out of commodities. Exchange traded products have now made it possible for individuals to gain direct exposure.
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To find products that invest in different classes of commodities, you can use our ETF Screener. The screener lets you drill down into commodity categories like agriculture, industrial metals, and precious metals. Within each of these categories you can further refine your screen using data points like expense ratios, historical performance, trading volume, and more.
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Slide 6: Investing in Commodities with ETFs
But be careful! Not all commodity products are created equal, and many may not work the way you expect. Morningstar ETF Analyst Reports can help you drill down into the details, so you know exactly what you are buying. Here's a rundown of some of the most commonly seen structures:
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The first group are products that physically hold the commodity you want to buy. ETFs like SPDR Gold Shares GLD buy gold bars for every share issued, and then store them in vaults in London. In this way the ETF tracks the price for immediate delivery (the spot price) of gold. This is as close as you can get to actually holding the gold yourself.
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Next are funds that buy futures contracts, or the promise to get a delivery of a commodity at a certain date and price in the future. These future contracts represent what the market believes a commodity will be worth in the future, not what it is trading for today. As those contracts expire, the fund must roll its assets over into new futures contracts. These inefficiencies can cause the returns of these funds to differ materially from the performance of the underlying commodity. This could be a shock to investors who bought a fund like United States Oil USO thinking they were getting direct oil exposure, but who soon discovered that their returns seriously lagged oil spot prices.
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There are also exchange traded notes that track commodity indexes. These funds are essentially debt instruments through which a bank promises to pay you the total return of a commodity index, less expenses. Most commodity indexes track futures contracts, so they are prone to the same inefficiencies of funds that directly buy contracts. ETNs can be more tax efficient, but they introduce investors to counterparty risk. That is, if the bank that is guaranteeing the note were to fail, investors could be left in the lurch.

Check out the portfolio construction portion of our ETF Analyst Reports to find out more about the index being tracked.

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Slide 10: Investing in Commodities with ETFs
Overall, commodities can help your portfolio, but make sure that you understand the downsides, that you know exactly what you are buying, and that commodities only make up a small portion of your total assets.
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Investing in Commodities with ETFs
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