Add Commodity Exposure With These ETFs

BALTIMORE (Stockpickr) -- On Main Street, the word "investor" is often synonymous with stocks. That's because traditionally, stocks have been the most accessible asset class for retail investors looking to get growth in their portfolios. They're also among the easiest to understand -- much easier to grasp than complex instruments like derivatives or potentially math-driven investments like bonds.

But as the financial world evolves, Main Street is quickly finding out that there's another kind of asset worth owning -- one that's even easier to understand. I'm talking about commodities.

Simply put, commodities are products such as gold, oil and rice -- items that are universal regardless of who produces them, and for which the market is able to set a base price. While commodity markets are less familiar to your typical retail investor, they've been a critical element of the financial system in some form for thousands of years. And now, they're more easily accessible to individual investors than ever before.

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The flight from stocks that accompanied 2008's stock market crash brought a new level of awareness to commodity investments. Suddenly, investors were being told to buy gold, or to invest in oil -- investments that don't necessarily move in concert with stocks.

Now, with the popularity of exchange-traded funds, it's easier than ever to add commodity exposure to your portfolio.

A Continued Rally in Commodities for 2011

Adding commodity exposure to your portfolio is an excellent way to diversify your portfolio away from stock market risks. And now, with commodity indices such as the Thomson Reuters/Jefferies CRB Index sitting atop multiyear highs, it makes sense to take a look at commodities.

Commodities have had strong performance for a few reasons. A flood of new investor dollars into these instruments has created scarcity among commodity investors, and at the same time, long-term trends are suggesting that many commodities remain undervalued relative to their historic valuations. And now, with the economy rebounding, demand has also increased for many commodities.

These factors all point to a continued commodity rally in 2011. So where should you look to add commodity exposure to your portfolio? With that question in mind, here's a look at 4 commodity ETFs worth looking at.

Precious Metals

Precious metals have been among the highest-profile commodities in the last few years, thanks in large part to the fact that metals such as gold and silver have long been tangible symbols of wealth. Since the onset of the recession, prices for metals have been one of the most heavily-touted examples of the rationale for investing in commodities.

And as a result, physical metals ETFs such as the SPDR Gold Trust ( GLD) have become incredibly popular investments. The funds, which invest in actual physical gold held at custodian vaults throughout the world, currently own more than 2,000 tons of gold bullion -- more than the gold reserves of China, India, and the European Central Bank combined.

It's worth noting that GLD is the top holding of George Soros at Soros Fund Management, comprising 9% of his total portfolio, and of John Paulson at Paulson & Co., comprising 17.6% of the total portfolio.

Of course, gold isn't the only metal that's investible through physical metal funds...

Silver actually looks like a much more attractive option right now, despite the fact that the metal's price more than doubled in 2010. That's because of silver's high industrial demand. Since silver is used in a number of production processes -- many of which actually destroy more silver each year than is mined -- this well-known metal is actually still trading at a substantial discount to its historic price.

While there are a number of options with silver funds, the ETFS Silver Trust ( SIVR) benefits offers investors a silver bullion-backed fund with an expense ratio of only 0.3% -- significantly lower than many of the other funds on the market.

Soft Commodities

Soft commodities -- agricultural crops such as coffee, corn, and wheat -- have long been used by farmers to hedge their risks. Now, though, they've become a popular option for retail investors as well.

Soft commodities are an excellent way to hedge against inflation. Because they're critical inputs for many of the products used by consumers (like the wheat used to make bread, or the cotton used to make clothing), increases in the prices of goods at the supermarket typically lag increases in the commodities themselves.

One of the most appealing soft commodity ETFs out there is the PowerShares DB Agriculture ETF ( DBA), which buys futures contracts on feeder cattle, cocoa, coffee, corn, cotton, lean hogs, live cattle, soybeans, sugar and wheat. While the fund's expense ratio is on the higher side of the spectrum (at 0.75%), its instant diversification, liquidity, and size make it an attractive option.

Energy Plays

Energy prices are one of the commodity costs that U.S. consumers are more aware of -- after all, we get reminders every time we're filling up at the pump. But rising fuel prices can actually be a boon to your portfolio. Just look at the aptly named U.S. Oil Fund ( USO), which invests in futures contracts for West Texas Intermediate light, sweet crude oil, or WTI. USO is a fairly cheap point of entry for would-be crude oil investors, but there are a couple of extra factors to consider when looking at this fund. Because of contango and backwardation (two futures phenomena), the fund will commonly exhibit tracking errors against the spot price of crude. While there are alternative funds that use futures rolling strategies to combat this, their sophistication is reflected in their expenses. For most, this fund should be sufficient to make broad bets on oil.

Major holders of USO include Wilbur Ross at Invesco Private Capital.

Oil prices aren't the only energy commodity worth speculating on. Other fuels, such as natural gas and heating oil, also have their requisite ETFs. For investors looking to get broad-based energy exposure with a single fund, consider taking a look at the PowerShares DB Energy Fund ( DBE), which invests in a basket of WTI, heating oil, Brent crude oil, gasoline and natural gas.

To see more ETF options for commodity investors, check out the Commodity ETFs portfolio on Stockpickr.

-- Written by Jonas Elmerraji in Baltimore.

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At the time of publication, author had no positions in stocks mentioned.

Jonas Elmerraji is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.

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