Investing in Commodity ETFs: An Ounce of Research is Worth a Pound of Gold

July 26, 2008

In our last post on commodities investing we talked about why you might want to start investing in commodities, and what a few of the investment options were.This time around we’re going to take a closer look at commodity Exchange Traded Funds (ETF’s.) and how to research them.

When you decide to invest in a commodity ETF, there are a few things you need to consider:

  • Do I want to invest in a single commodity like gold, or multiple commodities like oil and natural gas?
  • Do I want to invest in commodities within a single country like the USA or China, or several countries at once?
  • Do I want to invest in an ETF that actually holds the commodity (like gold) or an ETF that simply buys stock in the companies that hold the commodity?

The more research you do, you are going to find that there are nearly limitless ways to add commodities to your portfolio.

For simplicity’s sake we are going to pick just one, the iShares Dow Jones US Energy Sector Index Fund (IYE) and do a quick walkthrough of how you would decide whether or not it’s a worthy place to invest your money. The IYE tracks the energy sector of the Dow Jones Index.

Please do keep in mind that I am not a financial advisor – I don’t even play one on TV. I am giving you the method I use when I start to research a potential ETF.

It is worth saying that your financial adviser should also be able to answer all of these questions for you before they ever invest your money. Print this out, take it with you if you like. The more informed you are about where your money goes, the better off you will be.

ETF criteria generally looks like this:
The IYE:
(All screenshots are from

How long has the ETF been around? If you are using commodities to offset the risk in your portfolio, then you are going to want to choose an ETF that has been around long enough for you to get a good idea of how well it has performed in the past. Now, exchange traded funds are a pretty new phenomenon in the market, so as long as they have a history going back at least three to five years you can get a general idea of where they stand.

How much does it cost to run the fund? This is called the ETF’s expense ratio, and it’s the amount that they take off the top, just like a mutual fund’s management fees. You’re going to be looking for an amount around .25% and not more than .50%

You can see from the screen shot above that they IYE has an expense ratio of .48% – That’s a little high, but still within an acceptable range. If this is difficult for you to read, you can click here to open up the same information in a new window.

How are the ETF’s assets allocated, and what are they worth? Start by looking at ETF’s that have a total worth of at least $200 to $500 million dollars. (IYE fails this test) You are also going to want to look at how many shares they trade a day. A minimum of 100,000 to 200,000 shares traded each day is a good place to start. (IYE fails this test too!)

As far as asset allocation, that is going depend on what your goals are. In my opinion, IYE fails the diversification test. They are invested in several major oil companies, but I do not like that Exxon Mobil is 23% of the entire portfolio. I would prefer the main holding to be around 15% of the overall portfolio. In fact, the more diversified the better, because it exposes me to less risk. However not all investors are as interested in that as I am. You may find there are times where you willingly accept a little more risk in the hope of making a better profit.

How well has the fund done in the past? If you are planning on long term investing, the look at the performance of the fund since it started. If you are looking to invest short term, I’d look at how well the ETF did for the last 6 months to a year.

How high are the highs and how low does it go? Again, for stable long term investing, look for an ETF that’s worth stayed relatively stable, without huge peaks and valleys. This chart shows the ups and downs of IYE over the last month – It’s on a downward trend.

The Price to Earning Ratio – The P/E ratio is basically the share price divided by earnings per share. I mention this here because it is important, but I want to note that the P/E ratio for an ETF is not calculated in the same way that a P/E ratio for an individual stock is. So, while you may look at this first when considering an individual company, it is not really the best indicator for an ETF. For more information on why that is, you can check out this article.

Once you take all of these factors into account, and the investment still looks good to you, then you will want to request a prospectus from the company. This will go into far more detail than just what you see here, and it should answer most of the other questions you have about the stock and the management company.

What do you think? Based off this outlook would you consider IYE a good investment? You can give us your opinion in the comments section below!

The Beverly Hillbillies promotional photo is ©CBS Television. ShareBuilder screen shots are © ShareBuilder.

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6 Responses to Investing in Commodity ETFs: An Ounce of Research is Worth a Pound of Gold

  • aa

    Did you posts about commodities a couple years late?

    They’ve just been off their tops. Don’t tell us to average down from here!!!



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