This lesson provides insights into the structure of physically backed commodity ETPs, such as those underpinned by gold and silver, and how they work.
Physically Backed Commodity ETPs
Let’s take a look at the structure of physically backed commodity exchange traded products (ETPs) and see how they work.
All ETPs allow investors to gain exposure to an underlying asset or benchmark. To do this, ETPs need to be underpinned by the assets they’re designed to track.
There are two ways to do this:
- Physically or
An ETP issuer uses the money received from the creation of the ETP to buy the underlying target assets, but for most commodities, physical replication is unfeasible. Storage can be very expensive, infrastructure requirements may be considerable, and in the case of agricultural produce, the underlying asset is perishable.
So, for commodity ETPs, physical replication is only viable for a few mainly precious metals where storage is operationally simple and relatively cheap.
These physically backed commodity ETPs give investors exposure to precious metals without them having to take actual delivery of the underlying.
The metal is stored in a vault by a custodian bank specializing in the safeguarding of assets on behalf of clients. However, some physically backed precious metal ETPs allow investors to receive delivery of the underlying metal, if desired.
Storage and metal quality are subject to the standards of international trade associations such as
- the London Bullion Market Association (LBMA),
- the London Platinum and Palladium Market (LPPM), and
- the London Metal Exchange (LME).
The value of a physically backed ETP is based on its entitlement to a corresponding amount of the underlying metal.
An entitlement of 0.1 means there is one tenth of an ounce of metal held for each ETP security.
Investors also benefit from a secure investment structure, with the underlying metal owned by an independent trustee who holds it on behalf of investors. So, if an ETP issuer defaults, investors still retain ownership of the metal. The trustee would then sell the metal and distribute the proceeds to investors.
To sum up, physically backed commodity ETPs give investors the benefit of exposure to commodity price movements, and investors can rest assured that each ETP is backed by an entitlement to high quality, securely stored, physical metal.
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There is a substantial risk of loss in foreign exchange trading. The settlement date of foreign exchange trades can vary due to time zone differences and bank holidays. When trading across foreign exchange markets, this may necessitate borrowing funds to settle foreign exchange trades. The interest rate on borrowed funds must be considered when computing the cost of trades across multiple markets.
Disclosure: Leverage ETFs
Complex or Leveraged Exchange-Traded Products are complicated instruments that should only be used by sophisticated investors who fully understand the terms, investment strategy, and risks associated with the products. Learn more about the risks here: https://gdcdyn.interactivebrokers.com/Universal/servlet/Registration_v2.formSampleView?formdb=4155