For investors for whom the high cost of admission of index funds is daunting, there is the option of commodity exchange-traded funds. They include full-basket ETFs such as the iShares GSCI ETF (GSG), the iPath DJ-UBS commodity ETN (DJP) as well as commodity-specific ETFs such as United States Oil (USO) and the United States Natural Gas (UNG).
These funds offer immediate and easy access for retail investors, as they are traded and priced just like stocks. They are, however, uniformly horrible investments. The fund fees tend to be high. What's more, these funds are forced to use front-month commodity futures to correlate the fund's price to commodity prices. They're also forced to "roll" their futures positions every 30 days, a profit-robbing contrivance for shareholders. At best, commodity ETFs represent value for a just few days and are best used as a daytrading tool. Any long-term investment in these ETFs will vastly underperform the commodity basket's movement, whether up or down.
The final method for accessing commodity exposure is through managed futures funds -- like the doomed Peak Ridge and Amaranth funds. This is clearly the riskiest method for retail investors as you do not necessarily track the basket of commodity prices. You are, in fact, betting on a trader and his ability to outsmart a market, as with any other hedge fund. You do avoid the "roll premium" implied by most ETFs, but of course you also risk a possible "blow up" that wipes away all of your investment.
So what is the takeaway? If all three direct investment vehicles have unique handicaps, how should you invest?My advice is to commit to stocks that are directly correlated to commodities. In commodities such as gold and copper you can invest in mining stocks, and in oil and natural gas you can invest in energy producers. Unfortunately, there's no way to gain access to many of the soft commodities such as corn and coffee using this method. Of course, the human element of greed will ensure that we continue to see commodity funds raising easy capital from investors looking to capture some outsized gains, and we'll continue to see some of them explode, taking all the investor money with them. That's how inviting this overheated commodity market looks right now.