V. FUTURES-BASED COMMODITY ETPs
Due to their complexity and the potential of additional risks, a more detailed discussion of futures-based commodities ETPs is required. As mentioned above, most commodity ETPs seek to replicate indexes that consist not of physical commodities, but of exchange-traded futures contracts. Futures contracts are obligations to deliver or to accept delivery of a defined quantity of a physical or financial commodity at a particular place, time and price. Futures contracts are typically traded in the prompt or spot month as well as in forward months going out one to two years. Price differences across a series of futures contract months reflect the dynamic combination of current and expected commodity supply/demand fundamentals, current and expected interest rate and inflation levels, costs of storage and insurance.
While commodity futures will generally exhibit a strong correlation to the spot price of the related commodity, it is important to note that an investment in futures is not identical to an investment in the spot commodity. As mentioned previously, many commodity ETPs seek to replicate indexes comprised of futures contracts. As such, most of these products will exhibit strong positive correlations to the related commodity, but returns may vary significantly.
This has been a point of considerable confusion among ETF investors, as some have seemingly expected commodity ETPs to deliver returns equal to changes in the spot price of the relevant commodity. Returns generated by commodity ETPs comprised of futures are impacted by multiple factors, some of which have no relation to the spot price of the commodity or commodities.