Exchange-traded funds are investment vehicles that contain an array of different securities including stocks, bonds and commodities. Some ETFs invest in futures contracts for commodities such as oil and natural gas. In theory, the fund should take possession of the commodity on the purchase date listed in the contract. However, futures contracts are often rolled on renewed and this has an impact on the value of shares in the ETF and also can have an impact on the futures market.
ETFs are growth instruments that are structured like mutual funds but are sold like stocks. This means that ETF investors can sell their fund shares on the secondary market as opposed to redeeming their shares with the fund company. Commodities such as gold, oil and natural gas generally rise in value due to inflationary pressures. An imbalance between supply and demand can also cause a spike in commodities prices, and ETF managers attempt to capitalize on such price gains by buying commodities at low prices and then selling the commodities for much higher prices.
A futures contract involves a commodity owner entering into an agreement with a buyer to sell a commodity for a pre-determined price as some point in the future. ETFs buy these contracts with the expectation that the commodity will rise in value so that the market price of the commodity at the time of purchase exceeds the price detailed in the contract. However, an ETF cannot physically take possession of a barrel of oil or a container of gas and attempt to split the commodity between the fund's investors. Therefore, ETF managers attempt to sell the contract for profit before the expiration date. The ETF generates a profit from the sale and rolls that money into a new futures contract.
Supply And Demand
When demand for commodities rises, prices rise. When an ETF rolls a futures contract, the amount that it invests in the new contract exceeds the amount it invested in the previous contract. Competition for futures and commodities rises as more money comes into the commodities futures market. Assuming that no other factors are influencing the market, futures prices would always rise over time if ETFs and other fund companies continually rolled futures contracts.
While contact rolling does have an impact on futures contracts, many other factors also have an influence on the price of traded securities. During recessions, governments sometimes release oil reserves onto the market in an effort to drive down prices by ensuring that supply outstrips demand. If this occurs, the commodities prices in previously agreed futures contracts may exceed the current market price. Since an ETF cannot actually take possession of the commodity, it must roll the contract by selling it for a loss and then reinvesting in a more-expensive contract. When this occurs, the ETF and ETF investors lose money, but the rolling of the ETF does not have much of an impact on futures prices because other more powerful factors are driving prices down.
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