ETFs vs. Futures: What You Need to Know

    More and more investors are moving into exchange-traded funds to track the change in commodities frequently traded on the futures markets. One such ETF, the SPDR Gold Shares (GLD), has now grown to contain nearly $50 billion in assets, making it one of the largest ETFs on the market.
    More and more investors are moving into exchange-traded funds to track the change in commodities frequently traded on the futures markets. One such ETF, the SPDR Gold Shares (GLD), has now grown to contain nearly $50 billion in assets, making it one of the largest ETFs on the market.

    However, there are major differences between exchange-traded commodity funds and futures.

    Physical ETFs


    There are two different types of exchange-traded commodities funds: physical funds and futures funds.

    Physical exchange-traded funds do not hold futures positions and instead hold the actual commodity they are supposed to track. The SPDR Gold Shares (GLD) is a perfect example of a physical ETF. The issuer holds allocated gold in reserve to accurately track spot prices without holding futures contracts. These funds are usually the most accurate trackers of any exchange-traded fund, but can have higher annual fees due to physical storage. After all, storing millions of ounces of gold isn't exactly free.

    If the goal is to hold certain commodities for an unknown amount of time, physical exchange-traded funds are an excellent way to gain exposure to the market. Physical exchange-traded funds avoid any damaging contangos, even if they have slightly larger annual fees. Take in consideration, too, the cost of buying and selling exchange-traded funds of any type.

    Futures Based ETFs


    Within the subsection of futures based exchange-traded funds, there are the front-month exchange-traded funds and full-year ETFs.

    In a front-month exchange-traded fund, the issuer purchases futures contracts in the front-month, rolling them over as the contract expiration date comes. However, front-month exchange-traded funds are slowly going extinct, since the monthly rollover exposes investors to losses from a “contango,” which occurs when prices are higher for the next month than they are the current month.

    To solve the problem of time decay in futures positions, exchange-traded fund companies have slowly adapted to multi-month or full-year futures-based exchange-traded funds. Rather than purchase one month at a time, these funds spread investment dollars over a full year, limiting exposure to large contangos and limiting their impact on the futures market.

    At one time, United States Natural Gas Fund (UNG) owned as many as 33% of all contracts in any month on the natural gas futures markets. To reduce its market dominance, the fund switched to a full-year exchange-traded fund, spreading its assets over a full year of contracts.

    Futures-based exchange-traded funds are best held in the short term, where the full brunt of price contangos are avoided. If holding for longer than a few months, investors are almost always better off in pure futures or physical ETFs, where they can mitigate the exposure to a contango in futures prices.

    Pure Futures


    Pure futures positions are still the best way to play the futures market, if you know how long you wish to be in a certain contract, since physical exchange-traded funds incur annual fees, and futures-based ETFs leave investors with unnecessary risk.

    As you can see, exchange-traded funds and futures are two very different products with distinct purposes.

    Tim Ord
    Ord Oracle

    Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...

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