Posted on 26 June 2012.
Exchange Traded Commodities have become popular commodity trading vehicles in recent years for traders who want to be able to trade various commodities without opening a commodity trading account. While Exchange Traded Commodities have provided easy access to many traders who previously shunned the commodities market, because they did not want to engage in commodity futures trading, there are some important aspects regarding the nature of Exchange Traded Commodities that traders need to understand to avoid trading pitfalls.
Exchange Traded Commodities trade as Exchange Traded Funds (ETFs) or Exchange Traded Notes (ETNs) on major stock exchanges. Just about any commodity can be brought and sold via Exchange Traded Commodities. Popular commodities, such as gold and silver, can be traded as Exchange Traded Commodities via the SPDR Gold Trust (GLD) fund and the iShares Silver Trust (SLV) fund. Commodities that serve as industrial feedstocks can also be traded as Exchange Traded Commodities funds. The following are industrial feedstock Exchange Traded Commodities funds examples: iPath DJ-UBS Cotton ETN (BAL), Teucrium Corn Fund (CORN), iPath Dow Jones UBS Copper Total Return Sub-Index ETN (JJC), and iPath DJ-UBS Cocoa ETN (NIB).
Exchange Traded Commodities can also be traded through ETFs and ETNs that represent a basket of commodities that target a specific commodity sector. For example, if a trader or investor wants to trade the energy sector, they can buy a fund that invests in a number of energy related commodities, such as PowerShares DB Energy Fund (DBE), which invests in crude oil, heating oil, gasoline, and natural gas via futures contracts. For traders and investors that want broad exposure to agricultural commodities, the PowerShares DB Agriculture (DBA) invests in variety of agricultural futures, including but not limited to: coffee, corn, cotton, cattle, wheat, soybeans, and sugar.
Exchange Traded Commodities trade in the same manner as stocks via regular brokerage accounts, which means traders can buy and short sell Exchange Traded Commodities without opening up commodity trading accounts and without buying and selling commodity futures and options directly. Exchange Traded Commodities can be purchased using a margin brokerage account to increase an trader’s Exchange Traded Commodities buying power. The valuation and pricing of Exchange Traded Commodities are continuously updated during the trading day, based on the underlying value of the financial instruments, such as futures and options, used by the funds to track the value of the underlying commodities.
One aspect of Exchange Traded Commodities funds that traders and investors need to understand is that under certain market conditions these funds can lose value even if the underlying commodity futures prices are relatively flat or even slightly up, a condition that is known as price decay. Exchange Traded Commodities funds must sell the expiring futures contracts each month for the underlying commodity(ies) that they track. If the expiring futures contracts are worth less than the further out dated futures contracts that the funds must buy to replace the expiring ones, then the funds lose value as a result of the transaction. For this reason, many Exchange Traded Commodities funds are better suited for short term trading, rather than longer term investing, since the value of the funds may erode over time, even as the underlying commodities maintain their value. Some traders and investors take advantage of this situation by shorting Exchange Traded Commodities funds, and reaping the rewards if the funds lose value due to price decay.
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