Commodities Hit the Exchange (Again)

With commodities soaring, there's no shortage of new ways to invest in them.

The S&P GSCI Enhanced Commodity Total Return Strategy Index ETN (NYSE: GSC  ) is a new vehicle from Goldman Sachs that tracks the S&P GSCI Index, a diversified commodity index that contains 24 commodities ranging from energy to agriculture and precious metals.

ETNs, or exchange-traded notes, trade on exchanges but are different in several significant ways from better known exchange-traded funds (ETFs). ETNs are debt obligations of their issuer, which means that investors face credit risk related to the issuer. ETNs tend to track the price of commodities much closer than ETFs. Finally, ETNs held longer than one year are likely to be treated as long-term capital gains, which isn't always the case with ETFs because of special tax issues related to futures contracts.

Investors using futures to get exposure to commodities can face a phenomenon called contango. That occurs when the prices for contracts in later months are higher than those of closer contracts. When traders roll their contracts over, contango means you have to pay more, causing slippage between your investment's value and the spot price of the commodity. Goldman seeks to avoid some of the costs associated with contango by not always rolling into the next month's contract, purchasing contracts further out instead.

Full speed ahead
Commodities have had everything going for them lately. The boom in commodities has been driven in part by rapidly growing economies, such as those in China, India, and Brazil, which have pushed prices consistently higher. Gold and oil especially have seen strong demand and significantly higher prices. With increased interest in alternative fuels, corn has also experienced tremendous interest and price increases. Recent interest rate cuts by the Federal Reserve weakened the dollar's value and caused a subsequent rise in commodity prices as producers scramble to adjust for the dollar devaluation.

Commodities can provide significant diversification benefits to your portfolio because they make up a separate asset class from stocks and bonds. At the same time, commodities can be extremely volatile, so investors venturing into this sector should be careful of their exposure in this area. While Goldman's new ETN makes it relatively easy for investors to access this important asset class, it does charge a hefty 1.25% fee and is a new and untested fund.

Whether commodities will continue upward or correct is anyone's guess. With the onslaught of new ways to invest in commodities, however, history suggests that the more popular an investment becomes, the more likely it is to drop -- sooner or later.

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