With prices for most everything soaring, here's a primer on how to play the game using exchange-traded funds -- and a selection of the best ETFs to choose from.
Soaring commodity prices are driving the cost of food, gasoline, airplane tickets and just about everything else we want to buy to new heights.
As consumers, besides for cutting back on purchases, there's little we can do about this state of affairs. But for investors, rising commodity prices offer an opportunity to make some money. I'll get into specifics in a minute, but first some background.
Demand or speculation?
Commodities include corn, coffee, wheat, soybeans and almost all other agricultural products; crude oil, natural gas and heating oil; copper, lead and other industrial metals; gold and silver; and livestock.Many commodities are trading near record prices. Why? Some blame growing demand from emerging markets. Others blame speculators. Still others blame the diversion of corn crops to ethanol production.
This question isn't merely academic. If speculators are the driving force, commodity prices are in bubble space and sooner or later will come crashing back to earth. However, if the reasons are more fundamental, prices are probably headed higher.
Try your hand via ETFs
If you buy the fundamental argument, you can use exchange-traded funds, or ETFs, to profit from rising commodity prices.This is a relatively new opportunity. Most commodity ETFs have been available for less than two years. Before that, futures contracts were the only way to invest directly in commodities. But futures are short-term bets and too risky for most individual investors.
Another alternative is to buy shares of companies involved in the corresponding industry. For instance, you could buy an oil driller to gain from rising energy prices. But that doesn't always work. Often, related industry stocks don't follow commodity prices.
ETFs, as you probably know, are similar to index mutual funds. They track the performance of a specified index, for instance, the Standard & Poor's 500 ($INX). However, ETFs trade like stocks. There is no minimum investment, and you can trade them as often as you like.
Commodity ETFs usually track indexes reflecting futures prices. For gold and silver, ETFs actually track the prices of the metals. But the ETF shares do not trade at the commodity prices. For example, a crude-oil ETF doesn't trade at the same price as a barrel of oil. Instead, it trades at a specified fraction of the barrel price.
Nevertheless, ETF prices move by almost the same percentage as the commodity. For instance, if oil prices move up 10%, so would corresponding ETFs.
ETFs have expenses that keep them from fully replicating the commodity returns. For instance, a 1% expense ratio would subtract 1% from an ETF's annual return. Because most EFT expense ratios run below 1%, that's usually not a concern.
Put the tool to use
You can use MSN Money's ETF Performance Tracker to see how commodities are performing in general and to determine which commodities are outperforming.Except for precious metals, all commodity ETFs are listed in the "Specialty-Natural Resources" category. So, select that category and then choose the "show all" option. Last week, the report listed 59 natural-resources ETFs, sorted by their 52-week returns, with the highest-returning funds at the top. (Actually, only 35 of the funds had been trading that long).
Select "Specialty-Precious Metals" to find ETFs tracking gold and silver prices.
Last week, crude-oil funds topped the 52-week natural-resources list. Click on the column header for any of the time frames listed to rank the funds for those periods. Available periods range from one week to five years. Because most commodity funds are new, you'll probably find the one-week, four-week, 13-week and year-to-date reports the most useful, in addition to the table for 52 weeks.
When I checked, crude-oil and natural-gas ETFs dominated most time frames.
A strategy
Commodities are notoriously cyclical. That means it's probably a bad idea to assume that crude oil and natural gas will continue to outperform other commodities.Instead, diversification should be the name of the game. Yes, you'll probably miss a big move by diversifying, but investing success is more about avoiding big losses than it is about scoring home runs.
Here's a list of investable categories and my favorite ETFs for tracking them. I picked them based on longevity, returns, expense ratios and daily trading volumes. (I avoided lightly traded ETFs.)
Diversified commodities
iShares S&P GSCI Commodity Indexed Trust (CSG, news, msgs) tracks an index of 24 commodities weighted according to the proportion of the commodity flowing through the economy. The index is composed of 55% crude oil, 22% other energy products, 12% agricultural commodities, 7% industrial metals, 3% livestock and 2% precious metals. Expense ratio: 0.75%. 52-week return: 65%. Year-to-date return: 26%.PowerShares DB Commodity Index (DBC, news, msgs) is similar to iShares S&P GSCI but with less emphasis on energy. It tracks an index composed of 35% crude oil, 20% heating oil, 12% wheat, 12% corn, 11% aluminum and 10% gold. Expense ratio: 0.83%. 52-week return: 59%. Year-to-date return: 25%.
iPath Dow Jones-AIG Commodity Index Fund (DJP, news, msgs) puts even less emphasis on energy. It tracks an index composed of 34% energy, 33% agricultural, 16% industrial metals, 9% precious metals and 8% livestock. Expense ratio: 0.75%. 52-week return: 27%. Year-to-date return: 16%.
Diversified energy
PowerShares DB Energy Fund (DBE, news, msgs) tracks crude oil in two markets, heating oil, gasoline and natural gas.Expense ratio: 0.75%. 52-week return: 76%. Year-to-date return: 33%.
Crude oil
United States Oil Fund (USO, news, msgs) tracks the futures prices of West Texas intermediate light sweet crude. Expense ratio: 0.50%. 52-week return: 108%. Year-to-date return: 32%.iPath S&P GSCI Crude Oil (OIL, news, msgs) also tracks the futures prices of West Texas intermediate light sweet crude. The expenses are higher than with United States Oil, but its returns are in the same ballpark. Expense ratio: 0.75%. 52-week return: 110%. Year-to-date return: 32%.
Natural gas
United States Natural Gas Fund (UNG, news, msgs) tracks natural-gas futures contracts traded on the New York Mercantile Exchange. Reflecting natural-gas prices in general, returns were nothing to shout about last year, but they have taken off this year. Expense ratio: 0.60%. 52-week return: 5%. Year-to-date return: 50%.PowerShares DB Agriculture (DBA, news, msgs) is a pure play on the most widely traded agricultural commodities: soybeans, corn, sugar and wheat. According to PowerShares, tracking these four commodities reflects the performance of agricultural products in general. Expense ratio: 0.50%. 52-week return: 48%. Year-to-date return: 12%.
Precious metals
StreetTracks Gold (GLD, news, msgs) tracks the price of gold bullion. Expense ratio: 0.40%. 52-week return: 26%. Year-to-date return: 4%.iShares Silver Trust (SLV, news, msgs) tracks the price of silver. Expense ratio: 0.50%. 52-week return: 23%. Year-to-date return: 12%.
One warning: Over the years, some very smart people have gone broke playing commodities. So, don't use the money that you'll need for retirement or to put your kids through college.
Also, experts advise that you should never allocate more than 25% of your funds to any one sector. Given that commodities are particularly risky, I advise reducing that limit to 10% or 15% for them.
