Inflation generally remains a concern for most investors seeking to protect the purchasing power of their portfolios. Among the many strategies discussed to address those concerns, commodities have come up as a potential hedge. But how effective are commodity ETFs in protecting against inflation?
Generally Positive Correlation with Inflation
Commodity ETFs. follow the performance of various underlying assets, such as precious metals, oil, and natural gas. Certain commodity ETFs may offer broader exposure by tracking a diversified mix of multiple commodities.
Because the price of commodities. tends to rise in tandem with inflation, commodity prices have historically exhibited a higher positive correlation with inflation compared to traditional financial assets such as stocks and bonds.
Performance During Inflationary Spikes
Studies show that diversified baskets of commodities, such as precious metals, have the potential to perform particularly well, as compared to equities and fixed income, during periods of high or unexpected inflation. Research from Morgan Stanley also indicates that commodities can materially increase in value for every 1% rise in unexpected inflation, offering some protection against the erosion of real returns.
Diversification Benefits
Commodity ETFs can have low or even negative correlations. with stocks and bonds. This diversification may help stabilize overall portfolio returns, especially when inflationary pressures negatively affect both equity and fixed income markets.
Important Considerations and Limitations
Commodities are among the most volatile asset classes due to several key factors. They tend to be sensitive to geopolitical events, weather conditions, and supply-demand imbalances, all of which can cause rapid and significant price fluctuations. Additionally, commodities often have lower market liquidity compared to other asset classes, which may have the effect of amplifying price swings. These inherent characteristics tend to make commodities more prone to greater and more frequent volatility than many other financial instruments. While volatility can offer significant upside potential, it also increases the risk of sharp declines.
Contango and Roll Yield Impact
Most commodity ETFs gain exposure through futures contracts rather than physical commodities. When the futures market is in contango — that is, when futures prices exceed current spot prices — the ETF may incur negative https://www.investopedia.com/terms/r/roll-yield.asp. This happens when expiring contracts are sold at lower prices and replaced with higher-priced contracts, potentially reducing overall returns and causing the ETF to underperform the spot price of the underlying commodities.
Varied Performance Across Commodities
Not all commodities behave identically or consistently maintain their real value over time. Performance can be highly cyclical and influenced by unique supply and demand factors affecting individual commodities.
This underscores the importance of diversified commodity exposure rather than reliance on a single commodity.
How Well Do Commodity ETFs Hold Up?
Commodity ETFs can play a valuable role in hedging against inflation, particularly in periods of unexpected or rapidly rising prices. Their positive correlation with inflation, historical performance during inflationary shocks, and diversification benefits make them a credible tool to help with protecting purchasing power.
That said, they are not a one-size-fits-all solution. The volatility and varied behavior across commodities mean that investors should approach them thoughtfully. If you’re looking for broadly diversified, well-structured ETFs with commodity exposure Qtrade’s ETF Screener can filter ETFs according to their asset allocation, currency, and investing theme. If you click on the name of the ETF that interests you, it opens up detailed information, including price, performance, and Morningstar Analyst ratings and commentary.