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A n investor who wants to gain access to the commodity markets may, among other choices, do so by investing in commodity exchange-traded funds (ETFs). Commodity ETFs trade like ordinary shares and provide exposure to a wide range of commodities and commodity indexes, which include energy, hydrocarbons, metals, industrials, and agriculture. The first commodity ETF to reach the global marketplace was the Gold Bullion Securities launched on the Australian Stock Exchange in 2003; the first commodity ETF in the United States was the SPDR Gold Trust, which was launched by State Street SPDR on November 18, 2004. 1
In general, commodity ETFs are index funds that track non-security indexes but they can be equity-based in the sense that they may invest in a basket of equities which are associated with a commodity. Commodity ETFs that track non-security indexes are not regulated as investment companies under the Investment Company Act of 1940 in the United States and may be subject to regulation by the Commodity Futures Trading Commission. In addition, equity-based commodity ETFs may be significantly impacted by changes in the equity market. Occasionally, the impact on the pricing of commodity ETFs by the equity market may be more intense than the influence exerted by the underlying commodity markets themselves.
In order to invest in commodity markets, an ETF has two basic strategic options. The first is to invest in the commodity directly. These are the so-called physically backed commodity ETFs and have the benefit of closely matching the spot price of the underlying commodity, but they bear the load of costs relating to storage of the commodity. The second option is to get exposure to commodity markets through relevant futures contracts of a specific commodity or a range of commodities. This synthetic strategy is the most commonly adopted approach and has the advantage of avoiding storage costs relating to physical replication.
The futures-based approach is subject to the so-called "rolling costs." These costs are incurred because the ETF needs to roll the futures contracts that are about to expire by closing them out and reopening them as future-dated ones. The majority of futures-based commodity ETFs are front-month-only funds. This means that indexes place their assets into the nearest-month contract, rolling into the second-month contract...