One of the significant opportunities for investors over the past two decades has been the democratization of access to commodities – assets that were once the domain of specialized traders, institutional investors or those with the resources to deal in physical goods.
Commodities, energy products, precious and industrial metals, and agricultural goods, are integral to the global economy. They are also notoriously challenging for retail investors to access directly. Exchange-traded funds have changed that dynamic, giving Canadians the ability to incorporate commodities into their portfolios through familiar, regulated and highly liquid vehicles.
Right now, commodity ETFs are in high demand. Critical minerals like lithium and fuels of the future, like uranium, are ushering in the opportunity for a low-carbon future.
Commodity ETFs aim to track the price of a specific commodity or a basket of commodities. They are structured to give investors access to the underlying asset without requiring them to handle the complexities of storage, transportation or futures trading.
Physically-backed ETFs hold the actual commodity in secure storage. A gold ETF, for example, may store bullion in a vault that is independently audited. The share price of the ETF moves in line with the spot price of gold, giving investors the economic benefits of ownership without the logistics of personal custody.
Futures-based ETFs invest in standardized futures contracts that trade on regulated exchanges. This is common for oil, natural gas and agricultural products where physical storage is costly or impractical. The ETF manages the process of rolling expiring contracts into new ones, sparing investors from having to do so themselves.
Equity-based commodity producer ETFs invest in companies that produce or process commodities, such as mining companies, energy producers or agricultural firms. While their performance is correlated to commodity prices, it is also influenced by company-specific factors such as operational efficiency, debt levels and management decisions.
ETFs have opened commodities to a broader range of investors by addressing both accessibility and efficiency. There are four sectors:
- Precious metals: Gold, silver and platinum ETFs, particularly physically backed ones, have been among the most popular commodity products. They offer a way to hold a proven store of value in a portfolio without the challenges of securing physical metal.
- Industrial metals: Copper, uranium and lithium ETFs connect portfolios to the raw materials essential for infrastructure, manufacturing and emerging industries like electric vehicles and nuclear power.
- Energy: Oil and natural gas ETFs often use futures contracts to mirror price movements in the energy markets. This allows investors to express views on geopolitical developments, seasonal demand changes or shifts in OPEC policy.
- Agriculture: ETFs tracking wheat, corn, soybeans or coffee prices give investors a way to participate in agricultural markets affected by weather, trade policy and global consumption trends.
Canadian-listed commodity ETFs trade in Canadian dollars, offer currency-hedged versions and are regulated under Canadian securities law.
Risks and considerations
Prices can be volatile, driven by supply-demand imbalances, geopolitical events and natural disasters. Futures-based ETFs can be impacted by roll yield, when new contracts are more expensive than those they replace. This indirect cost can influence investor experience and ETF outcomes.
Currency fluctuations can also influence returns for unhedged products.
Investors should understand whether their ETF is physically backed, futures-based or equity-based. Each behaves differently and carries its own cost structure.
Advisors should also include fund provider experience, fund methodology, the ETF’s underlying liquidity and tradability and ETF costs (direct and indirect) in their due diligence review process.
In terms of costs, consider the ETF’s management expense ratio, trading expense ratio, the cost of trading the ETF within the brokerage firm and other indirect costs such as the bid-ask spread cost of the ETF itself.
The latter is often linked to the underlying asset liquidity profile and can have a meaningful impact if an ETF is traded regularly.
Whether an investor is seeking to diversify, hedge inflation risk or take a tactical view on global trends, commodity ETFs offer a transparent, regulated and efficient pathway.
Eli Yufest is executive director of the Canadian Exchange Traded Funds Association (CETFA).