Commodity ETFs Vs. Commodity Futures: Which One Is Better?

• Commodity exchange-traded funds (ETFs) invest in a commodity by purchasing or disposing of the underlying asset that the ETF is designed to follow or by purchasing or disposing of futures contracts on the underlying asset.
• Commodity futures are derivatives with a finite life span.
• An ETF that provides futures contracts on the assumption that the underlying asset will appreciate will face a challenge known to experts in the futures business as contango.

Commodity ETFs are beta-driven investments with a low reliance on manager competence and a focus on generating returns from the market alone. Public shares that are related to a particular economy, market index, sector, or industry typically make up ETFs. 

Normal ETFs are made up of a collection of equities linked together by a common investment approach. Instead of underlying securities like public equities, commodity ETFs are composed of futures or asset-backed contracts that track the execution of a particular commodity or group of commodities.

Difference Between Commodity ETFs And Commodity Futures

The investment vehicles referred to as commodity exchange-traded funds (ETFs) are beta-driven and aim to earn returns mostly from the market with little reliance on manager competence. This results in a long-only bias in a commodity exchange-traded fund (ETF), and if the ETF uses futures as the vehicle, other problems will follow. Future commodities are derivatives with a short shelf life. 

Contango is a barrier that is well-known to experts in the futures market that affects ETFs that provide futures contracts on the assumption that the underlying asset will increase in value.

In futures markets for underlying resources that are not perishable, contango exists. Examples of this type of market include gold and oil. This situation arises when the price of one of these underlying resources in the futures market exceeds the price in the marketplace for cash. It is demonstrated by the fact that each succeeding futures contract in a sequence with delivery dates further in the future displays a higher price. The long-term commodity ETF will be essential to close out its current holdings and roll into a futures contract with a delivery date further into the future as the current futures contract addresses expiration and an alignment among the futures and cash markets is discovered.

Contango will reduce the ETF’s returns since the contract price of the position that has been settled will be less than the price of the newly opened position. There is no spread between these two positions in the spot markets. Profiting from the rollover effect will be possible for commodity ETFs that hold holdings in regular futures markets. When the prices of several futures contracts are dropping, an effect called ‘backwardation’ results. 

This situation was deemed to be normal by John Maynard Keynes. His justification was the rising cost of transporting a basket of products that must be kept until the delivery date, which is getting later and later. Backwardation is the opposite of contango, which happens when there are perceived shortages or a rapid rise in demand for the underlying assets. 

Conditions for managed futures programs run by commodity trading consultants are varied. Compared to a long-only strategy, these alpha-returns-seeking methods are much more adaptable.