We take a look at how investors can gain exposure to a several parts of the commodities market via ETFs.
As we have mentioned recently, inflation expectations have increased to their highest levels in years. One of most common methods of positioning a portfolio for rising inflation is to include an allocation to commodities. As a result, many investors may be wondering about the best way to gain exposure to commodities. Prior to the inception of ETFs commodities were largely only accessible via futures which were primarily the domain of institutional investors. ETFs now offer average investors relatively easy access to commodities. However, there are a few differences between equity and commodity ETFs to be cognizant of.
Many ETFs gain exposure to commodities via futures contracts which means that most of these funds will generate a K-1, unless they use a structure specifically designed to avoid it. Other ETFs, specifically precious metals ETFs, are backed by physical metal and are taxed as collectibles, which is typically a higher tax rate than capital gains. Finally, there are ETNs, ETNs don’t hold futures or physical commodities, they are a debt obligation of the issuer. These funds are not taxed as collectibles and they don’t generate a K-1; however, investors in ETNs are exposed to the credit risk of the issuer. Below is a list of commodities and funds that can be used to gain exposure to each.
Crude Oil
The largest oil ETF on the market in terms of assets is the United States Oil Fund USO with over $3 billion in AUM. USO gains exposure to crude oil through futures contracts and investors in the fund will receive a K-1. The fund holds futures contracts up to ten months out, so there will be some difference in the performance of USO and the front month oil contract, which is what is typically quoted when discussing the daily performance of oil. This brings up another point about ETFs that hold futures – roll yield. In a normal market the oil futures curve is in backwardation, i.e., the futures price is below the spot price. If the price remains the same, the futures contracts that the fund holds “roll” up the curve to the spot price, generating positive roll yield. When the market is in contango, the opposite is true, which produces negative roll yield. Roll yield is not the most important aspect to the overall performance of oil ETFs, but is a factor to be aware of. You can check to see the current state of the oil futures curve on the CLCONTANGO chart.
Those who do not want to receive a K-1 can consider the Proshares K-1 Free Crude Oil Strategy OILK. Like USO, OILK also gains exposure to oil via futures contracts; however, it is structured to avoid generating a K-1. One thing worth noting is that, while many people try to avoid a K-1, typically the K-1 tax treatment is actually better.
Gold
The largest gold ETF on the market is the SPDR Gold Trust GLD. GLD, like most other gold ETFs on the market, holds physical gold and will receive the collectibles tax treatment discussed above. Another large gold ETF is the iShares Gold Trust IAU; IAU also holds physical gold so avoiding the collectibles tax treatment may not be possible through ETFs here.
Silver
The iShares Silver Trust SLV is by far the largest silver ETF on the market with more than $17 billion in AUM. Like GLD, SLV also holds physical silver. Investors who want exposure to silver but without the unfavorable tax treatment could utilize an ETF like the Global X Silver Miners ETF SIL. SIL is an equity ETF that holds silver mining companies; while the performance of these stocks is correlated to the price of silver it does not offer the pure exposure of a fund like SLV.
Those who want exposure to a basket of precious metals in a single ETF could consider the Invesco DB Precious Metals Fund DBP. DBP currently holds 76.70% gold and 23.3% silver. Unlike most other precious metals funds, DBP’s portfolio consists of futures. This means that investors in the fund will receive a K-1, which may provide more favorable tax treatment than funds that hold the physical metals.
Industrial Metals
The largest industrial metals ETF is the Invesco DB Base Metals Fund DBB. DBB’s portfolio includes copper, aluminum, and zinc. As with the Invesco’s precious metals fund, the fund holds futures and thus investors will receive a K-1.
Investors looking for exposure only to copper can consider the United States Copper Fund CPER. Like DBB, CPER gains its metals exposure through futures, so investors will receive a K-1.
There are funds that offer exposure to single industrial metals including tin, aluminum, and lead; however, all of these funds have low levels of assets, many under $10 million. As a result, liquidity may be poor, and they are likely excluded from the approved list at many firms.
General Commodities
There are options for those who want exposure to a basket of commodities in a single fund, like the Invesco DB Commodity Index Tracking Fund DBC. DBC offers exposure to a wide range of commodities including crude oil, natural gas, precious metals, copper, industrial metals, and agricultural products. DBC does generate a K-1.
Luckily for those who want general commodities exposure without a K-1, DBC has a K-1 free counterpart, the Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF PDBC. PDBC offers exposure to the same basket of commodities as DBC.
