A commodity ETF is an exchange-traded fund that provides access to commodity markets without the need to directly purchase physical commodities or engage in complex forward transactions. Commodity ETFs are like stocks with no fixed term and can be traded daily on the stock exchange. They use synthetic replication via swap transactions to replicate the performance of commodity indices.

The ETF engages in a swap agreement with a financial counterparty, which provides the return of the underlying commodity index after deducting a swap fee. This structure enables the ETF to precisely replicate commodity indices without you having to face the technical challenges of commodity trading yourself.

Commodity ETFs track diversified commodity indices and spread their portfolio across various commodity categories such as energy, metals, or agricultural products. Commodity ETCs, on the other hand, usually focus on individual commodities such as gold, silver, or platinum.

Since commodity ETFs invest via futures contracts (and individual commodities are not physically delivered), they must be “rolled” regularly – this means that expiring contracts are sold and longer-term ones are purchased. This change can cause additional gains or losses, regardless of the actual commodity price development. Futures contracts with different maturities have different prices, which form a price curve. The slope of this curve determines whether it is contango or backwardation.

Contango refers to a situation on the futures market where the price of a futures contract is higher than the current spot price of the underlying asset. The spot price is the price at which the underlying asset can be purchased and delivered immediately. When rolling, the more expensive longer-term contracts must be purchased and cheaper expiring contracts sold, which can lead to roll losses. If longer-term contracts are more expensive than short-term contracts, the price curve rises. Contango is often associated with high costs of carrying the commodity, including storage, insurance and financing costs, which are reflected in higher prices for longer‑dated contracts.

Backwardation refers to the opposite situation. The curve falls when longer-term futures contracts are cheaper than the spot price. This results in roll gains, as expensive expiring contracts are sold and cheaper longer-term contracts are purchased. Backwardation is typically observed when physical supply is tight or when the benefits of holding the physical commodity, often referred to as the convenience yield, outweigh storage and financing costs.

The return on commodity ETFs comes from three sources: The change in the spot price, the roll yield, and the swap yield. The spot price reflects the direct price development of the commodity. The roll yield arises when switching from expiring to longer-term futures contracts and can be positive (backwardation) or negative (contango) depending on the market situation. The swap yield results from the income or costs incurred by the swap counterparty when entering into the swap.

There is no single best commodity ETF; rather, different ETFs are more or less suitable depending on individual investment objectives and market conditions. The choice depends on which commodity sectors are preferred and how diversified a portfolio should be. The composition of a commodity ETF and the proportions of different commodities represented in the ETF can usually be found on the website of the respective provider. Some ETFs, for example, exclude the agricultural sector entirely, while others place a particularly strong emphasis on energy commodities such as oil and gas. Still others focus more on precious metals or industrial metals. These different weightings make it difficult to compare commodity ETFs (as well as other ETFs) with one another. An ETF with lower costs may perform worse than a comparatively expensive ETF if the latter's commodity composition is better suited to prevailing market conditions. Conversely, an ETF with lower fees may achieve a better return if its weighting of commodity markets proves advantageous during the period under review.

Commodity ETFs do not pay dividends because the underlying commodities themselves do not generate any current income. Unlike stocks, which pay dividends, or bonds, which pay interest, physical commodities such as oil, gold, or wheat do not generate regular cash flows.

Directly purchasing physical commodities is often not particularly practical. Commodities are therefore often traded via futures contracts, in which buyers and sellers commit to purchasing or delivering a specific quantity at a specified future date. However, direct futures trading is complex and usually reserved for institutional investor groups.

Commodity ETFs and commodity ETCs can be a practical solution for you if you are interested in commodities. These financial products provide access to commodity markets without you having to deal with the technical challenges of futures trading. ETF or ETC shares can be purchased like stocks through a traditional securities account.