Benefits of Trading COMEX Precious Metals Futures vs. ETFs

Because leverage also has equal potential to magnify losses, however, using the maximum available leverage may not be aligned with the average investor’s goals or risk tolerance. The amount of leverage used can be reduced by simply adjusting the amount of margin on deposit. Giving consideration to right-sizing a position within a portfolio and using prudent risk management tools such as stop-loss orders can provide some protection from potential downside risk resulting from leverage.

COMEX Gold futures trade nearly 24 hours a day with excellent liquidity, reflecting the 24-hour global over-the-counter (OTC) market for gold. Conversely, Gold ETFs typically trade like equities, and are not available to most investors on a 24-hour basis. The 24-hour availability for futures allows for trading as major market events unfold rather than having to wait for the market to open to initiate a position, potentially missing trade opportunities. Due to ETFs’ restrictive trading hours, investors are subject to overnight gap risk: the risk that the ETF price will jump from one level to another with no trading in between. This can be problematic for traders wishing to use stop-loss or limit orders. 

With over $40 billion of average daily dollar volume across COMEX Gold and Silver futures in 2017, the liquidity of COMEX precious metal futures greatly surpasses that of comparable ETFs. As shown in the table, and using the average daily volume in terms of ounces as the measure of liquidity, COMEX Gold futures offer approximately 40 times the liquidity when compared to the largest Gold ETF (SPDR Gold ETF).

Similarly, COMEX Silver futures offer approximately 64 times the liquidity when compared to the largest Silver ETF (iShares Silver Trust ETF). Furthermore, COMEX Gold and Silver futures open interest measured in notional value exceeds the assets under management of the largest comparable ETFs as shown below.

Liquidity Comparison of Precious Metals Futures vs. ETFs²

This large liquidity differential between futures and ETFs could have an impact on execution costs, specifically market impact. Market impact measures the adverse price movement caused by the act of executing an order. As the previous table shows, COMEX Gold futures on average trade approximately 40 times as much as the largest comparable ETF.

Although the average bid/ask percentage of the larger, more liquid ETFs appear to be on par with futures, a large ETF trade could potentially move the market to a much greater extent when compared to futures. For example, an order of $1,000,000 represents less than .003 percent of average daily notional value of trades in Gold futures ($37.4B), but 0.11 percent of average daily dollar volume of the GLD ETF ($0.9B).

Tax Implications³

Gold futures have the potential to be a more tax-efficient vehicle for short-term trades compared to Gold ETFs. Taxation of capital gains on a futures position follows IRS Section 1256, meaning capital gains on Gold futures held for one year or less are treated as a 60 percent long-term gains and 40 percent short-term gains for tax purposes. Assuming an investor is in the top marginal tax bracket, this results in a blended maximum effective short-term rate of approximately 30.2 percent⁴. Gold ETFs are taxed as collectibles, and therefore are taxed at the maximum short-term capital gains tax rate of 37 percent for positions held for one year or less. 

Easier to Short

Investors attempting to take advantage of the negative performance of a precious metal can choose to go short either ETFs or futures. The process of shorting an ETF, however, often can be costly and complicated.

To short an ETF, an investor will borrow ETF shares from a broker and sell those shares with the intention of buying them back later at a lower price, profiting from the decline in price. The investor must deposit an initial minimum deposit of 50 percent of the sale price due to the Fed’s Regulation T margin requirements.

Additionally, the broker will charge the short seller borrowing fees for the ETF shares lent. The lending rates on shares borrowed vary based on market interest rates, the size of the margin loan, the broker offering the loan and demand for the security being lent. For a typical retail investor, the cost to borrow shares of an ETF typically range from 2% to 10% (annualized) and varies based on average daily debit balance.

When trading futures, it’s just as easy to initiate a trade from the short side by selling a contract as it is from the long side. The futures short seller does not need to borrow shares or pay the associated borrowing fees but instead posts a margin deposit or performance bond to secure the transaction. The same limitations to the use of leverage when going long an ETF also apply when taking a short position in an ETF, again limiting the flexibility of the investment vehicle. 

Conclusion

Precious metal ETFs may have their place in a diversified longterm investment portfolio; however, the many drawbacks and limitations of ETFs outlined within make it clear that COMEX Precious Metals futures are an alternative investment vehicle. 

1 For illustrative purposes only: As of 12/04/17, 1 Feb 18 Gold futures contract = $1,277.7 * 100 troy ounces = $127,770 * 50% = $63,885.

2 As of 12/29/2017. Source: CME Group, Bloomberg.

3 Please note this is not intended to be advice regarding tax treatment and it is advised that you contact a professional tax attorney or accountant for information that is applicable to your specific situation.

4 (60 percent*37 percent maximum short-term capital gains tax rate) + (40 percent*20 percent maximum long-term capital gains tax rate). Tax rates reflect 2018 short-term and long-term capital gains rates.