Today’s Daily Angle comes from Wikinvest Wire member Hard Assets Investor. You can read the full article on the Hard Assets Investor Blog.

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For the average investor, the commodities markets can be daunting. Many investors don’t possess the capital and/or risk tolerance necessary to invest directly in the futures markets. Further, although the number of online brokerages that offer futures trading is growing, for the most part, buying or selling commodity futures requires setting up a special account, which, for many retail investors, may be more trouble than it’s worth.

Enter the commodity ETF.

Commodity ETFs are relatively new, but that hasn’t stopped them from attracting investors—in 2009 alone, commodity exchange-traded products brought in $30.1 billion in new investment. Although some precious metals funds actually hold the goods in question—the SPDR Gold Trust (NYSE: GLD), for example, actually keeps gold bars in a vault—this strategy is impossible for most commodities, whose worth is determined by their usefulness. As such, commodity ETFs purporting to track prices in other classes of good require some type of derivative investing; in the commodities world, that means futures contracts.

However, by their very nature, commodity ETFs allow investors to make longer-term bets on the value of a given commodity than is typical in the futures market. The futures trader makes money simply if the price of oil for delivery in a given month goes up between now and that month’s contract expiration. But for the fund investor, who buys shares of an oil ETF expecting the price to rise over the next several months or years, the case is not so cut and dried.

As we’ve covered before, it comes back to the structure of the fund. If, for example, an ETF holds only the front-month contract for a given commodity, then that contract must be sold before its expiration, and the next (soon to be front-month) contract must be purchased in its place. Since the two contracts are almost certain to have some price discrepancy, the difference on this roll must be factored into the return of the fund.

What’s more, a futures-based commodity ETF is part of a secondary market on top of the already volatile futures market. As investors buy and sell shares of what is essentially ownership of other financial instruments, the fund’s value may fall out of whack with the commodity it is purporting to track. After all, demand for an ETF may be very different than demand for the futures contracts that ETF tracks: Just look at the U.S. Natural Gas Fund (NYSE: UNG). With these potential pitfalls in mind, let’s compare the relationships between several energy commodity ETFs and the front-month prices of the commodities they purport to track. A regression analysis should help us get an understanding for how well (or poorly) a given ETF truly tracks a commodity.

Let’s look at the funds with the highest trading volume in oil, natural gas and gasoline: the U.S. Oil Fund (NYSE: USO); the U.S. Natural Gas Fund (NYSE: UNG) and the U.S. Gasoline Fund (NYSE: UGA)]]. Each of these funds invests in the front-month contract only, reflecting the simple, long and unleveraged approach. All data is close of day from the fund’s inception to 2/12/2010, as compared with equivalent sessions for each commodity.

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