An exchange-traded commodity, or ETC, is a financial instrument that allows investors to gain exposure to the price movements of a financial commodity, without having to own the underlying asset. ETCs are traded on the stock exchange and are a convenient way of investing in commodities indexes. 

Here’s how a typical ETC works on the stock market:

• An ETC is designed to track the performance of a specific commodity or a basket of commodities. It is structured similarly to an ETF and is typically backed by physical commodities or derivatives 
• ETCs are created by Authorized Participants (AP). APs are large financial institutions that have the authority to create more shares of an ETC or to redeem existing shares. When new shares are created, the AP delivers the underlying commodities to the ETC issuer to exchange them for shares. When shares are redeemed, the AP receives the underlying commodities instead 
• ETC are often created with the purpose of tracking an underlying commodity index. The ETCs are structured in order to very closely replicate the performance of the index 
• In terms of trading, ETCs are no different from stocks and ETFs and are freely traded on major stock exchanges
• Since commodity prices can be highly volatile, ETCs can come with relatively more risk than most regular stocks. However, this also makes them attractive to short-term traders

ETCs are typically not directly invested in commodities like commodity ETFs are. The assets of an ETC are often a debenture issued by a bank (i.e. the APs). 

ETFs vs ETCs - Key Differences 

The key difference between ETCs and ETFs lies in the underlying asset. ETFs are a broad class of assets that can be invested in anything be it stocks, bonds, crypto, precious metals, etc. 

ETCs, on the other hand, are focused on commodities including gold, and their assets are notes issued by financial institutions, as opposed to the physical assets that are held by ETFs. 

For example, the United States Oil Fund ETF, or USO, is an ETF that invests in a range of derivatives of Brent crude, while the iShares Physical Gold ETC tracks the price of gold on the global market using financial derivatives, while retaining gold reserves to accurately track the price. 

Another important difference is the trading hours of these assets:

• ETFs trade on the same market hours as any other stock 
• ETCs typically trade on the same hours as the commodities they are tracking 

The structure of ETFs and ETCs is also different. ETFs are often structured as open-ended funds, unit investment trusts (UITs), or grantor trusts, while ETCs are often structured as trusts. 

Counterparty risk is another key point of difference between the two:

• ETCs may carry counterparty risk, particularly if they use derivatives to track commodity prices. Investors are exposed to the creditworthiness of the issuer or counterparty providing the derivative exposure. If the counterparty becomes insolvent, the ETC becomes worthless, even though the asset that it’s tracking still retains int value 
• ETFs have some mechanisms in place to mitigate counterparty risk. For example, many ETFs hold collateral assets for this purpose

Let’s look at a practical example of an ETC, such as the iShares Physical Gold ETC. The ETC is traded on the London Stock Exchange under the SGLN ticker. 

The ETC is backed by gold bullion which is held in a secure vault. Investors who buy shares in SGLN are gaining exposure to the movements of the price of gold on the market. 

SGLN has returned -1.3% since the start of the year, which has been a part of the gradual slowdown of gold price growth in 2023. 

The ETC was first issued on April 11, 2011, and has become one of the most popular gold ETCs on the market, with an on-book turnover of over GBP 2.76 million. 

SGLN, much like other gold ETCs, has a few important advantages, such as:

• Liquidity - buying and selling gold ETCs is very easy and can be done in seconds via a stock brokerage account 
• Cheap to own - SGLN has an ongoing charge rate of just 0.12%
• Tax advantage - gold ETCs can be held in self-invested personal pensions, or SIPPs, which means that capital gains taxes are not payable upon selling 

Before putting your capital at risk, it is important to consider the inherent risks and benefits associated with trading exchange-traded commodities to decide whether it is the right course of action for your financial objectives. 

Pros

• Diversification - ETCs allow investors to diversify their portfolios by gaining exposure to a variety of commodities without having to buy and store physical assets. This can help spread risk and reduce the impact of poor performance in any single commodity
• Liquidity - ETCs are traded on major stock exchanges, providing investors with high liquidity during regular trading hours 
• Convenience - ETCs provide a simple and efficient way to invest in commodities without the need to manage physical storage, transportation, or handling costs associated with owning actual commodities 
• Transparency - ETCs often track an underlying commodity index, making it easier for investors to understand what they're investing in. The tracking of an index also provides a level of transparency regarding the investment's performance
• Low costs - ETCs typically have lower expense ratios compared to actively managed funds. This can result in cost savings over time, especially when compared to investing directly in commodities or commodity futures
• Short-term trading - ETCs can be traded throughout the day, enabling short-term trading strategies such as day trading or swing trading

Cons

• Market risk - ETCs are subject to market risk, which means their prices can be highly volatile based on changes in commodity prices, supply and demand dynamics, geopolitical events, and other factors
• Tracking error - While ETCs aim to track the performance of an underlying commodity index, there can be slight discrepancies between the ETC’s performance and the index’s performance due to factors like tracking errors and management fees 
• Commodity price volatility - Commodities markets can experience significant price volatility due to factors such as weather conditions, geopolitical tensions, changes in technology, and shifts in global supply and demand
• Lack of ownership - When you invest in an ETC, you don't actually own the physical commodity. Instead, you hold shares in a financial product that is designed to mimic the price movements of the commodity
• Management fees - While ETCs generally have lower expenses compared to actively managed funds, they still have management fees that can eat into your returns over time
• Counterparty risk - ETCs are typically structured as debt securities or derivatives, which means investors are exposed to the risk of the issuer’s default or financial instability 
• Regulatory changes - Changes in regulations or tax policies can impact the trading and taxation of ETCs, potentially affecting your investment returns
• Complexity - Understanding the intricacies of commodities markets, tracking indices, and the performance of ETCs can be complex, especially for novice traders 

• Exchange-traded commodities, or ETCs, are financial instruments that allow traders to gain exposure to the price movements of an underlying commodity 
• ETCs are structured as debentures and derivatives that track the price of an underlying commodities index, without directly investing in the underlying commodity
• ETCs offer lower expense ratios, but can also be more volatile than other funds, due to the nature of commodity prices 
• ETCs are more suitable as short-term trading instruments, which is convenient for scalpers and day-traders