Exchange Traded Commodities

Submitted by Sharemarket News on 1 July, 2011 - 18:04

Everything about Exchange Traded Commodities (ETCs).

Exchange Traded Commodities are like ETFs, but ETCs give the investor exposure to precious metals such as gold and silver or a combination of precious metals. Instead of buying actual gold for example, you buy an ETC that tracks gold.

Since the underlying asset is precious metals, distributions are not paid for ETCs. Returns come in the form of capital growth. This is how it works: You get a metal entitlement and a metal share when you buy an ETC. The share is merely an instrument for trading; it's the entitlement that gives value to your ETC.

An entitlement is your right to a quantity of physical bullion. When you trade ETCs, you are actually trading the metal entitlement. Where is this bullion stored? In a vault. Yes, the precious metal is kept in a vault either in London or Zurich. Every day, your entitlement is reduced by a small amount to reflect an annual management fee (example 0.40 percent).

An ETC over gold means that a specific quantity of golf is held by a custodian. Commodities underlying the ETC are traded in $US and commodity prices are typically quoted in US dollars.

Pricing

The price of the underlying commodity and the AUD-USD exchange rate affects ETC price. Note that the base currency of the ETC is in US dollars. This means that the price of the ETC tracks the price of the underlying metal. But ETCs are quoted in Australian dollars in the ASX, so the ETC value in US dollars must be converted to AUD.

Risks

ETC holders are exposed to risks. The two major risks are commodity price and currency risk. Commodity prices can be volatile; prices rise and fall significantly in a short period of time. Since the base price of a precious metal is in US dollars, the ETC must be converted from AUD to USD.

This means that a strong Australian dollar actually works against you. A drop in AUD against the USD is favourable. Even though the price of commodities is on the upward trend, if the AUD is strong, your ETC value can drop.

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