Investing via Futures, ETFs, and Stocks
Ways to Access Commodities
Investors seeking commodity exposure have three main paths: trading futures contracts directly, buying commodity-focused ETFs, or owning shares in companies that produce commodities. Each approach has distinct mechanics, costs, and risk characteristics.
Choosing the right vehicle depends on your investment size, time horizon, tax situation, and comfort with complexity.
Direct Futures Trading
Futures contracts are agreements to buy or sell a commodity at a specified price on a future date. Trading futures provides direct exposure to commodity price movements.
How Futures Work
When you buy a crude oil futures contract, you are agreeing to take delivery of 1,000 barrels of oil at a set price on the contract's expiration date. Most traders close positions before expiration rather than taking physical delivery.
Margin requirements: Futures trade on margin, meaning you deposit a fraction of the contract's full value. Initial margin for crude oil might be $6,000-8,000 per contract, representing roughly 8-10% of a $75,000 contract value (1,000 barrels at $75/barrel).
Mark-to-market: Your account is settled daily. If the contract price moves against you, losses are deducted from your margin account. If losses exceed your margin, you must deposit additional funds or the broker will close your position.
Leverage: The margin system creates leverage. A 5% move in oil prices produces roughly a 50-60% gain or loss on your margin deposit.
Roll Costs
Futures contracts expire. If you want to maintain exposure, you must sell the expiring contract and buy a later-dated contract. This is called rolling.
When markets are in contango (future prices higher than spot), rolling costs money. You sell the cheaper near-month contract and buy the more expensive far-month contract. Over time, this roll cost reduces returns even if the commodity price stays flat.
When markets are in backwardation (future prices lower than spot), rolling generates positive roll yield because you sell high and buy low.
Who Futures Suit
Direct futures trading suits:
- Experienced traders comfortable with leverage and daily margin calls
- Investors with at least $25,000-50,000 to meet margin requirements
- Those seeking precise, short-term commodity exposure
- Tax-advantaged accounts where 60/40 treatment provides benefits
Commodity ETFs
Exchange-traded funds offer commodity exposure through standard brokerage accounts without futures account requirements.
Physically-Backed ETFs
Some ETFs hold the physical commodity in secure storage:
GLD (SPDR Gold Trust): Holds gold bullion in bank vaults. The ETF price tracks gold spot prices closely. Annual expense ratio is approximately 0.40%.
SLV (iShares Silver Trust): Holds physical silver. Works similarly to GLD but with higher storage costs relative to value.
Physically-backed advantages: No roll costs, tight tracking to spot prices, straightforward structure.
Limitations: Only practical for non-perishable commodities with low storage costs relative to value. Gold and silver work; crude oil and agricultural commodities do not.
Futures-Based ETFs
Most commodity ETFs use futures contracts rather than physical holdings:
USO (United States Oil Fund): Holds near-month WTI crude oil futures. Rolls contracts monthly.
UNG (United States Natural Gas Fund): Holds near-month natural gas futures.
Futures-based structure: These ETFs buy futures contracts and roll them before expiration. The ETF's returns equal the futures return minus expenses.
Contango Drag on Futures ETFs
Futures-based ETFs can significantly underperform the spot commodity price due to roll costs in contango markets.
Example: From 2009 to 2019, crude oil spot prices roughly doubled. USO, the largest oil ETF, lost money over the same period due to persistent contango and roll costs.
This tracking difference can be substantial. Over a year with modest contango (5% annualized), a futures ETF might underperform the spot price by 5% before expenses.
| ETF Type | Roll Costs | Storage Costs | Spot Tracking |
|---|---|---|---|
| Physically-backed (GLD, SLV) | None | ~0.25-0.50%/year | Tight |
| Futures-based (USO, UNG) | Variable, often negative | None | Can diverge significantly |
Commodity Equities
Owning shares in commodity-producing companies provides indirect commodity exposure with additional factors affecting returns.
Producer Stocks
Oil and gas exploration companies, mining firms, and agricultural producers have earnings tied to commodity prices. Higher commodity prices generally increase revenues and profits.
Advantages: No roll costs, potential for dividends, company-specific growth opportunities, stock market liquidity.
Complications: Company performance depends on management quality, cost structure, reserve quality, and balance sheet strength. A well-run producer can outperform commodity prices; a poorly-run one can underperform even in a rising market.
MLPs (Master Limited Partnerships)
MLPs are publicly traded partnerships common in energy infrastructure (pipelines, storage, processing). Many distribute most of their cash flow to unitholders.
Structure: MLPs issue units rather than shares. Limited partners receive distributions rather than dividends.
K-1 tax forms: MLPs send K-1 forms rather than 1099s. K-1s are more complex, may delay tax filing, and can create issues in retirement accounts (Unrelated Business Taxable Income, or UBTI).
Yield focus: MLPs historically offered yields of 5-10%, attracting income-focused investors.
Royalty Trusts
Royalty trusts own mineral rights and distribute production revenues to unitholders. They provide exposure to commodity prices without operating risk.
Declining production: Most royalty trusts have declining production over time as reserves deplete. High current yields may not be sustainable.
Tax characteristics: Distributions may include return of capital, which reduces cost basis rather than creating immediate tax liability.
Vehicle Comparison Table
| Vehicle | Direct Futures | Physically-Backed ETF | Futures-Based ETF | Producer Stocks | MLPs |
|---|---|---|---|---|---|
| Leverage | High (8-15x typical) | None | None | None | None |
| Roll costs | Direct exposure | None | Significant in contango | None | None |
| Minimum investment | $25,000+ typical | Share price | Share price | Share price | Share price |
| Tax treatment | 60/40 gains | Collectibles (28% max) for gold/silver | 60/40 gains | Standard capital gains | K-1, complex |
| Commodity tracking | Precise | Tight | Can diverge | Indirect | Indirect |
| Company risk | None | None | None | Yes | Yes |
| Income potential | None | None | None | Dividends possible | Distributions typical |
| Complexity | High | Low | Moderate | Low | High |
Tax Considerations
Tax treatment varies significantly by vehicle:
Futures (60/40 rule): Regardless of holding period, futures gains are taxed 60% at long-term capital gains rates and 40% at short-term rates. This benefits short-term traders compared to regular short-term rates.
Gold and silver ETFs: Taxed as collectibles with a maximum 28% rate for long-term gains, higher than the standard 20% maximum for stocks.
Futures-based commodity ETFs: Generally receive 60/40 treatment similar to direct futures.
Producer stocks: Standard capital gains treatment. Qualified dividends taxed at preferential rates.
MLPs: Complex taxation including potential UBTI issues in retirement accounts. Distributions may be partially return of capital.
Decision Checklist
When choosing a commodity investment vehicle, consider:
- What is your investment size? (Futures require more capital)
- What is your time horizon? (Roll costs compound over time)
- Are you comfortable with leverage and margin calls?
- Is this for a taxable or tax-advantaged account?
- Do you want pure commodity exposure or company upside?
- Can you handle K-1 tax forms if considering MLPs?
- What is the current futures curve shape (contango or backwardation)?
Key Takeaways
Direct futures provide precise commodity exposure with leverage, but require larger accounts and involve daily margin settlements. Roll costs can significantly affect returns in contango markets.
Physically-backed ETFs like GLD offer simple, low-cost exposure to precious metals. Futures-based ETFs are convenient but can significantly underperform spot prices due to roll costs.
Commodity producer stocks and MLPs provide indirect exposure with additional company-specific factors. MLPs offer higher yields but come with K-1 tax complexity. Tax treatment varies significantly across vehicle types, affecting after-tax returns.