.jpg)
Exchange-Traded Commodities, which are also known as ETCs, refer to financial instruments that enable investors to have a direct stake in commodities such as gold, silver, oil and farm produce, among others, even if they do not own the actual items. With commodities taking up increased importance in portfolios when there is inflation, unstable markets and geopolitical tensions, it is crucial to know what ETCs are.
Explaining
What ETCs Are
ETCs are
like ETFs in that they are exchange-traded securities designed to follow the
movement of prices of individual commodities or groups of commodities. Investors can access the futures market through their regular
brokerage accounts using ETCs, unlike conventional commodity futures
trading.
Most ETCs
take the form of debt securities that are provided by a third party, such as a
bank. The value of these instruments varies directly with the underlying
commodity price net of fees. In many cases, ETCs are said to be physically
secured or linked with futures contracts.
How ETCs
Work in Practice
For
instance, physically backed ETCs keep the real commodity in safe custody. Gold
ETCs provide a good example for this case, whereby every unit is supported by a certain amount of physical gold stored under maximum security. By closely
following spot prices, this structure minimises some risks associated with
futures markets.
On the other
hand, some ETCs use futures contracts for exposure, especially in commodities
like crude oil or natural gas, which cannot be easily stored. These ETCs roll
futures contracts over time, introducing additional costs and performance
differences.
ETCs trade
all day long, enabling investors to buy or sell at market prices like they would
with stocks.
Why
Investors Use ETCs
ETCs are
commonly employed for two main reasons: first, to diversify investment
portfolios since commodities usually act differently from stocks and bonds, thereby assisting in balancing them during times of rising prices or falling
markets; secondly, they are popularly used for short to medium term positions.
Traders use
ETCs to take views on commodity prices without having to open futures accounts
or deal with margin requirements.
Those linked
with precious metals or energy prices can be used as inflation hedges.
Risks
Investors Should Know
ETCs have
unique risks compared to traditional funds. Investor credit risk is faced by
those who invest in many ETCs, which are debt instruments. Even if commodity
prices rise, holders of ETC could be at risk should the issuing bank become
insolvent.
Roll costs
may affect futures-based ETCs, especially in contango markets, leading to
underperformance vis-à-vis spot prices.
Commodity
prices themselves can be very volatile due to factors such as supply
interruptions, weather conditions and changes in global demand.