If you’ve ever thought about investing in something like gold, wheat or oil, but don’t exactly know how to go about it, fear not. Doing so doesn’t necessarily require you to stockpile bars of bullion, bundles of wheat, or barrels of oil (or worse, deal with futures). Instead, you can consider commodity ETFs – funds that specifically invest in raw materials. Below, we look into why they’ve become popular investments, and how they could fit into someone’s investing strategy.

What are commodities and why do people invest in them?

Commodities are the raw materials and agricultural products we use every day or rely on to produce goods.

The category is broad and includes:

• Precious metals like gold and silver
• Other metals such as iron, copper and lithium
• Energy resources like oil, gas and hydrogen
• Agricultural products such as wheat, corn, sugar and even livestock

There are several reasons why commodities are popular with investors. A big one is that they can provide a hedge against traditional investments, like shares and bonds. See, when the stock market is performing poorly , commodities have historically moved in the opposite direction. Commodities also tend to rise in value during high-inflation periods, because they’re physical assets whose value increases when prices do.

Lastly, fluctuating supply and demand can make certain commodities more attractive investments. Take lithium, for example, which is a key metal in EV production, energy storage and other technologies. Thanks to increasing demand for each over the last few years, the price of lithium has gone up considerably. (More recently, though, it went south – largely because EV demand in China slowed.)

It’s worth mentioning here that futures are closely associated with the commodities market. Rather than investing in the physical products themselves (because who has the space to store actual gold?), commodity investors usually trade futures contracts. This allows them to speculate on future prices and potentially profit from price fluctuations.

As an alternative to futures, investors also invest in stocks related to a particular commodity – like energy providers, mining companies or agricultural companies.

How do commodity ETFs work?

Commodity ETFs provide yet another option for investing in raw materials. They're pretty much exactly as their name suggests: exchange-traded funds that primarily deal with commodities.

Much like other ETFs, commodity ETFs can be traded on the ASX , which is a big part of their appeal. They also expose investors to a wide range of commodities without having to buy the actual goods.

There are several types of commodity ETFs. Some invest in a single commodity, like gold. Others contain a diverse mix, like Commodity Tracking PowerShares (DBC) , which invests in sectors including crude oil, natural gas, gold, aluminium, corn and sugar.

Broadly speaking, commodity ETFs fall into these categories:

• Physically-backed ETFs: These ETFs actually hold the physical commodity. For example, a silver ETF like Silver Trust ETF iShares SLV keeps silver bullion in vaults in London. The majority of physically-backed ETFs are in metals, simply because they’re easier to store and there’s an established market for them
• Futures-based ETFs: Rather than the commodities themselves, futures-based commodity ETFs offer exposure to futures contracts. They’re more common with commodities that are tricky to purchase and store. These include oil, gas and agricultural products such as soybeans, wheat and corn
• Equity ETFs: This type of ETF invests in companies associated with commodities like mining, drilling or energy companies. A good example would be BetaShares Global Energy Companies ETF (FUEL) , which invests in major energy providers around the world

What are the pros and cons of investing in commodity ETFs?

Like any investment, there are potential advantages and drawbacks to commodity ETFs. Here are some of the main ones to think about.

Potential pros

• Easy access: Purchasing physical commodities or trading futures contracts can be complex and sometimes require specialised knowledge. On the other hand, commodity ETFs are relatively accessible investments, especially for newer investors. They can be bought and sold on the ASX, much like other ETFs and individual shares
• Diversification: Several commodities, such as gold, silver, and platinum, are seen as defensive assets. These commodities tend to retain their value and historically have fared pretty well during market downturns, making them attractive options for diversifying a portfolio
• Hedge against inflation: Because the prices of physical goods like oil and wheat tend to correlate with inflation , many commodities are popular investments during periods when inflation is high
• Cost-effective investments: Investing in physical goods can be expensive: there are fees like procurement, storage and insurance to think about, which is why many investors opt for futures contracts instead. Even futures contracts come with expenses, like account keeping. This can make commodity ETFs more appealing because they typically have lower investment fees
• A range of options on offer: Whether you’re looking to invest in a single commodity or a mix, there’s a bunch of commodity ETFs on offer. Different commodity ETFs suit different investing strategies , risk tolerances and investing goals

Potential cons

• Potentially volatile: Because commodities are physical goods, they’re at the mercy of several external influences like fluctuations in supply and demand, natural disasters and geopolitical events. All of these can influence their prices, which consequently affects the value of the commodity ETFs that invest in them
• Regulatory risks: Commodities are massively subject to regulation, such as trade and environmental policies. These can impact returns because they might put restrictions on certain activities
• Futures-based commodity ETFs: Futures-based ETFs come with their own set of possible drawbacks. The first is a phenomenon known as contango, whereby future prices are above spot prices. Over time, this can eat into returns. Backwardation is the opposite process, where future prices are below spot prices. This can boost returns for investors, but it doesn’t happen often. Plus, research shows that futures-based commodity ETFs typically have a higher tracking error than physically-backed ones. This is for several reasons, including higher fees than physically-backed commodity ETFs and other costs associated with future contracts

How could they fit in within a portfolio?

Whether you’re a first-time or seasoned investor, commodity ETFs could have a solid place in your portfolio – particularly if you’re looking to diversify your investments.

From a diversification perspective, commodity ETFs can open you up to several different markets and assets. You might already be investing in popular industries such as tech and finance. But perhaps you're looking to add a commodity to the mix so you can help protect your existing investments.

The potential benefit of including commodities in your portfolio is that they could help safeguard your other shares from the effects of a market slump. Because they typically have a low correlation with these kinds of investments, they may be able to mitigate any possible losses during downturns. And if inflation rates are going up, you might opt for a commodity ETF that has historically hedged against it.

Many investors also go for commodity ETFs if they’re looking to capitalise on certain trends or emerging technologies. If we look again at the rising demand for lithium, several commodity ETFs offer exposure to lithium and related equities without the need to invest in them directly.

Renewable energy is another interesting example. Previously, resources like hydrogen and biofuels weren’t seen as commodities. But that attitude is changing as nations look to alternative fuel sources. As such, more and more commodity ETFs are focusing on each resource.

Remember that these are only reasons why you might choose to include commodity ETFs in your portfolio, not a recommendation to invest in them. Always do your own research before deciding to invest, and reach out to a licensed financial adviser if you need further support.

What are some popular commodity ETFs on Pearler?

Pearler lets you invest in a wide range of commodity ETFs. Below are some of the most popular.

The operative word here is ‘popular’! Once again, we’re not making a recommendation – we’re simply listing the commodity ETFs that are favoured among members of the Pearler community.

AU

• Global X Hydrogen ETF (HGEN) : This ETF tracks the Solactive Global Hydrogen ESG Index, which focuses on a range of companies involved in the hydrogen industry. They might produce, store or distribute hydrogen, or get involved in hydrogen technology (such as hydrogen fuel cells)
• BetaShares Global Uranium ETF (URNM) : URNM tracks the performance of the Indxx North Shore Uranium Mining Index. Similarly, it includes companies involved in uranium mining – a mineral crucial for producing nuclear energy
• VanEck Australian Resources ETF (MVR) : MVR provides exposure to some of the biggest companies in Australia’s resources sector. These companies are involved in commodities like coal, gas and precious metals, as well as related industries. Some of MVR's most notable names include BHP, Rio Tinto, Woodside and Fortescue Metals
• VanEck Gold Miners ETF (GDX) : This ETF also invests in a diverse range of companies – however, all of them are involved in gold mining. In fact, it’s the biggest gold miners ETF in the world
• BetaShares Energy Transition Metals ETF (XMET) : XMET exposes investors to a range of metal companies involved in the clean energy transition. These companies produce metals like copper, lithium, graphite and rare earth elements, all of which support the production of renewable energy, EVs and battery storage

US

• Global X Lithium & Battery Tech ETF (LIT) : Rather than exclusively investing in lithium, LIT encompasses the entire lifecycle, from lithium mining to battery production
• Global X Uranium ETF (URA) : This ETF exposes investors to a variety of companies involved in uranium mining and the production of nuclear energy
• Gold Shares SPDR (GLD) : GLD invests in physical gold and is currently the biggest physically backed gold ETF in the world
• Global X Copper Miners ETF (COPX) : This ETF aims to track the Solactive Global Copper Miners Index, an index that reflects the global copper mining industry
• AdvisorShares Pure US Cannabis ETF (MSOS) : It might not be the first example that springs to mind, but cannabis is considered a commodity much like any other crop. MSOS gives exposure to a range of US companies involved in cannabis production

Before you go, a word on commodity ETFs…

While commodity ETFs do have their place in a portfolio and could be a valuable addition to your investing strategy, think about whether investing in them is the right move for you.

Consider your financial goals, your investing strategy, your investing horizon and, finally, your risk tolerance. While some commodities are considered ‘safer’, others are more speculative and may require a deeper understanding or extensive research. Always reach out to a financial adviser if you’re unsure of your next investing move.

To help you better understand the world of ETFs and commodities, make sure to check out these similar articles:

• “Should I invest in gold?”
• How do ETFs work?
• How to choose the right ETF for me

Happy investing!