How can I invest in commodities via ETFs?

Question:

How can I invest in commodities via ETFs? What are the options and what are the risks involved?

Response:

Investors can gain exposure to commodities via ETFs in two ways – either via ETFs which track the price of a particular commodity such as gold or through ETFs which track the performance of the resources index. Neither way is right or wrong but investors should be aware of the different outcomes each style of ETF provides.

Investors looking for pure exposure to the performance of a specific commodity such as gold should look at ETFs which track the market price of the actual underlying commodity. An example is BetaShares Gold Bullion ETF (A$ Hedged) (ASX:QAU). Backed by physical gold bullion held in the vault of JPMorgan in London, this product offers pure gold exposure. In addition, the ETF is hedged to the Australian dollar so that currency fluctuations are excluded from the investment decision. Commodity prices are generally quoted in US dollars but locally listed ETFs are quoted in Aussie dollars. Therefore, if the ETF is unhedged, investors are exposed to movements in currency as well as the commodity. Investing in a hedged ETF allows investors to obtain exposure to the price of the commodity itself.

History has shown that currency fluctuations can have a dramatic effect of investor returns in commodities. For example, if we look at the performance of gold bullion since the beginning of 2009, the gold price in US$ appreciated approximately 50%. Over same period, gold prices quoted in A$ returned negative six per cent as the local dollar appreciated against the US dollar. If the ETF is hedging this exposure, investors can substantially remove the impact of movements in the AUD/USD exchange rate from the commodity price.
Another method by which ETF investors can obtain exposure to commodities involves purchasing an ETF which tracks the performance of a basket of resources companies. For example, there are sector specific ETFs such as BetaShares’ QRE which aims to track the price and income performance of the S&P/ASX 200 Resources Index.

The advantage of investing through a locally listed sector ETF is a diversified exposure to companies which mine for different commodities such as iron ore, coal and gold without exchange rate risk. For example, QRE currently offers investors exposure to the returns of a basket of 66 of the largest resources companies listed on the ASX. Investors should understand, however, that equity sector ETFs introduce company specific and broader stockmarket risk and are an indirect exposure to commodities performance.

The two styles of ETFs allow investors to gain exposure to commodities in different ways. Investors should choose their ETF based on the type of exposure the investor prefers (equities v. the commodity itself) and their investment goals. If an investor is looking for pure exposure to a specific commodity, then choose an ETF which tracks this price. Otherwise, an equity sector ETF is better suited to those who want an indirect diversified exposure to the resource sector through company stocks.

By Drew Corbett, Betashares Head of Investment Strategy and Distribution, Betashares

Drew Corbett is the Head of Investment Strategy and Distribution of BetaShares, a specialist provider of Exchange Traded Funds (“ETFs”) which are traded on the Australian Securities Exchange. Australian-owned and managed, BetaShares is affiliated with BetaPro Management, one of the largest ETF issuers in North America. For more details, visit the BetaShares website.