Should a Commodities ETF Be Part of Your Portfolio?

by Ron Haynes

Short answer? Probably not, unless you’re an extremely aggressive investor who has a strong understanding of how commodities and commodities ETFs work.

What are commodities?

Commodities are things you can hold and that have an active investing market. Stocks, while you can hold them in a certificate form, are just pieces of paper that represent ownership in a business. Bonds are just pieces of paper representing the debt an entity holds. Commodities are things like gold, silver, oil, lumber, wheat, coffee, cattle, and metals. They are physical, tangible things.

gold_coin Why do investors buy commodities ETFs?

Most commodities have a very low correlation with the main stock market indexes. For example, the price of gold generally (though not always) rises when stock fall. Similarly, the rise in the price of oil very often accompanies or foreshadows a slow decline in stock prices. Due to the low correlation between commodities and stocks, investors usually buy commodities ETFs as a way to hedge the overall stock market. Hedging refers to the practice of buying two investments whose returns tend to have a low correlation, in an effort to reduce risk.

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Two types of commodity ETFs

1. Single-commodity ETFs

These ETFs track the performance of only one commodity, such as oil, gold, or silver.

2. Commodity index ETFs

These track the performance of a diverse group of commodities. It may include a set of agricultural products (wheat, cattle, pork bellies), metals (gold, silver, nickel, and tin), or energy products (oil, natural gas, uranium). Others may combine things like cattle, corn, and gold or even uranium, coffee, and lumber. The thinking is that a commodity index ETF can garner gains from a more diverse set of products.

Why you should probably avoid commodities ETFs

  • High risk – commodities are extremely volatile and therefore very risky. Investors can make or lose a great deal of money in a very short time period.
  • Returns – over the long term, stocks have to outperformed commodities significantly. The price of gold has historically risen at a rate roughly equal to inflation, keeping its return after inflation close to zero. Recent history has been different, but there’s no guarantee the gains realized over the past few years will be sustainable.
  • Taxes – currently, the IRS considers commodities (including most commodities ETFs) to be collectibles, similar to stamps or coins. Collectibles are taxed at rates roughly double those of long-term capital gains so if, despite my recommendation, you’re determined to own commodities ETFs, it’s probably best to hold them in a tax sheltered retirement account like a Roth IRA.

Photo by kevindooley

About the author

Ron Haynes has written 988 articles on The Wisdom Journal.

The founder and editor of The Wisdom Journal in 2007, Ron has worked in banking, distribution, retail, and upper management for companies ranging in size from small startups to multi-billion dollar corporations. He graduated Suma Cum Laude from a top MBA program and currently is a Human Resources and Management consultant, helping companies know how employees will behave in varying situations and what motivates them to action, assisting firms in identifying top talent, and coaching managers and employees on how to better communicate and make the workplace MUCH more enjoyable. If you'd like help in these areas, contact Ron using the contact form at the top of this page or at 870-761-7881.