I have been thinking about commodity ETFs and ETNs as part of an investment portfolio, and I have some questions.
What is the average rate of return on agricultural commodity ETFs and ETNs? I’m specifically looking at wheat, soy, and barley.
Commodities don’t gain income, so they’re based off of pure pricing. Does this mean that I’m basically trying to pick ones that beat inflation?
How long do people typically hold on to a commodity ETF or ETN? I see that ETNs held for a year+ get taxed as long term capital gains, while ETFs are always subject to the futures hybrid tax system (60% long-term 40% short-term). This makes ETNs more attractive to me, although I don’t know if there is a difference in rate of return.
How bad is tracking error on ETFs (the difference in performance between the ETF and the commodity it tracks)? Do ETNs have trading error?
Thanks for your help. I’d appreciate any answers as well as your experience with these investments.
I’m guessing you are in the wrong forum, but I will give you a one main point to consider. The majority of investments in commodity ETFs will be futures contracts. You need to, therefore, have a strong understanding of futures before you even consider investing.
Here’s just one example of why that might matter. Let’s say you are investing in a market that is in contango, which basically means that the futures curve is upward sloping. You then could lose money simply on the roll-forward from one contract month to the next even if the general price of the commodity remains relatively flat. To explain a little further, if the ETF is currently mostly invested in the March futures contract, which is trading at $10, and the April contract is $11, then when you get close to the expiration of the March contract, they will not be able to sell their March contracts and get an equal number of April contracts since April is trading higher. Therefore, they buy less contracts. If April trades back down to $10, you have lost money even though the underlying commodity stayed right at $10.
Isn’t that mostly the equivalent of interest on the huge leverage that futures represent?
Don’t futures prices generally have an interest component to them?
For example the price of gold one year from now will tend to cap at the current price of gold plus the prime rate because any price higher than that and people will borrow money, buy gold and sell the future.
And will tend to floor at the current price plus the risk free rate because if it were lower, people who owned gold would sell gold, invest it at interest and buy the future.
If the increase in the price of gold doesn’t increase at least at the rate of interest, you lose money because futures are so leveraged. If ETFs held things with delta that was closer to 1 I don’t think you havge that problem, its the leverage that killed you I thought.
There is the school of thought that a future price should simply be the cost to borrow at the spot price and store it. Otherwise, you would have arbitrage opportunities as you just brought up. However, if that were the case, why would futures curves so commonly be in backwardation?