5 Best Commodity ETFs to Buy Now

Commodity prices often move based on escalating geopolitical tensions, as they did last spring in the wake of surgical strikes on Iran by Israel and supported by the United States.

More recently, investors have sought the perceived safety of hard assets amid increased uncertainty due to the U.S. government shutdown.

Besides speculative gains, commodities can also be useful for hedging inflation. But for most retail investors, buying physical commodities outside gold and silver directly (which you can do at Costco) isn't realistic. It's not like you can store barrels of oil or bushels of wheat in your garage.

While investing in commodity-producing companies such as agriculture, mining or energy stocks might offer partial exposure, they're not perfect substitutes; stock prices also reflect company-specific risks including debt, management quality and operating costs.

To get around this, many investors turn to commodity exchange-traded funds (ETFs), which trade publicly and offer diversified exposure to commodity markets. But these funds don't usually hold physical commodities. Instead, they typically invest in futures contracts.

As you'll see, choosing the best commodity ETF isn't as simple as picking the one with your favorite raw material in the name. You'll need to take a close look at how each fund gets its exposure and be prepared to navigate some hidden tax traps along the way.

The ins and outs of commodity ETFs

Outside of precious metals, such gold and silver ETFs, most commodity funds don't own physical commodities. Rather, they gain exposure through futures contracts.

A futures contract is a derivative that obligates the buyer to purchase (and the seller to deliver) a specific amount of a commodity at a set price on a future date. The ETF is therefore holding contracts that reflect bets on future commodity prices.

For example, an ETF designed to track the price of West Texas Intermediate (WTI) crude oil doesn't buy and store barrels of oil. Instead, this fund might buy WTI crude oil futures contracts.

That's a key point. When you buy a commodity ETF, you're not getting direct exposure to the current (spot) price of the commodity. You're getting exposure to the price of a specific futures contract or basket of different ones, depending on the fund.

For instance, the spot price of oil might be $65 per barrel in June, but the ETF could be holding July contracts, which might trade higher or lower. While futures and spot prices are generally correlated, they're not identical and don't always move in lockstep.

This leads to another critical concept: contango. Futures contracts for commodities trade along what's known as a futures curve, a plot showing prices for delivery in various future months.

In a contango market, futures prices are higher than the current spot price, a common condition for many commodities, especially oil.

Here's why that matters: Futures contracts expire. When July comes around, our hypothetical crude oil ETF can't hold the July contract anymore. It must roll the position by selling the expiring July futures and buying a one dated later, say August.

But when the futures curve for oil is in contango, August contracts are more expensive than July. That means the ETF sells low and buys high, locking in a small loss each time it rolls.

This repeated cycle creates what's called negative roll yield, which is a performance drag over time.

For long-term investors, this can mean that even if spot prices rise over time, your ETF's return might be much lower or even negative due to the cost of rolling futures in a contango environment.

There's one more wrinkle: taxes. Some commodity ETFs are structured as commodity pools, which means they issue a Schedule K-1 tax form (PDF).

This is more complex than the standard 1099 tax form and can delay filing, especially for investors with multiple K-1s. The K-1 form also introduces complications such as potential state-level tax obligations and more detailed reporting requirements.

The bottom line: Commodity ETFs can be useful for short-term tactical exposure, but between futures-based tracking, roll costs and tax complexity, they're not always investor-friendly for long-term buy-and-hold portfolios.

How we chose the best commodity ETFs

We began by screening out the riskiest corners of the commodity ETF space. That meant excluding funds that use leverage or inverse exposure, as well as those that concentrate on a single commodity such as oil, gold or natural gas.

Commodities are already volatile, so most investors, unless they're active traders, are better off with long-only ETFs that hold a diversified basket spanning energy, metals and agriculture.

Next, we filtered for tax simplicity. Specifically, we only included ETFs structured to avoid issuing a Schedule K-1 form.

Some of these are clearly labeled "No K-1" in the fund name, but for others, you must dig into the prospectus or tax documentation to confirm. Avoiding K-1s makes tax reporting easier and helps sidestep delays and state-level complications.

From there, we applied a two-part screen:

Liquidity: We prioritized ETFs with a reasonably low 30-day median bid-ask spreads to minimize trading costs.

Reputability: We looked for funds with sufficient assets under management (AUM), as a proxy for stability, scalability and investor trust.

For commodity ETFs, expense ratios weren't as big a concern. Complexity in this space naturally drives costs higher, and most offerings are far more expensive than passive equity or bond ETFs.

But while there's less basis for comparison, it's still worth shopping around and taking note.