Today, more than ever, investors have several ways to use gold as an investment vehicle. This includes gold IRAs which we have covered before and gold ETFs and gold futures.
Both of these alternatives come with the essential benefits of holding gold in your portfolio. For one, it still serves as a portfolio diversifier. Secondly, gold remains one of the strongest hedges against inflation. That’s very important if you are creating a long-term investment, such as a retirement account.
With that in mind, which is the better investment vehicle between gold ETFs and gold futures? This post explains everything you need to know.
What are gold ETFs?
Gold exchange traded funds (ETFs) are passive investment instruments that are designed to track domestic prices of physical gold. When the price of gold bullion goes up, so does the gold ETF stock price. Similarly, gold ETF prices fall with a fall in gold bullion prices.
Gold ETFs are, in fact, commodity funds. They trade like stocks and are backed by gold. However, you don’t actually own the gold in its physical form. Rather, you simply own small portions of gold-backed assets 6
Are gold ETFs a good idea?
Gold ETFs are great if you want to invest in gold without having to buy it in its physical form. Alongside diversifying your portfolio, gold ETFs can help you manage risk.
That’s because gold is traditionally a safe asset that is countercyclical and not volatile. It can add a layer of protection to your retirement account or any investment portfolio for that matter.
Besides, gold ETF stocks are not subject to tax and VAT. And you can use them as collateral for loans. Therefore, adding this type of asset to your portfolio can increase your access to liquidity and help you build wealth. On the downside, gold ETFs typically have continuous fees related to management and marketing. Plus, you will be hit with a tax charge if you decide to sell the fund. This is what makes it, by and large, illiquid compared to gold futures.
What are gold futures?
Gold futures refer to gold contracts that are traded on the COMEX market. The contract is essentially a transaction that is completed on a particular date, but the buyer doesn’t get the commodity until a set date in the future.
In other words, you pay for the gold purchase now but get the delivery in future. You don’t need to hold the yellow metal in its physical form. Instead, the contract acts as a substitute for your gold.
Are gold futures a good investment?
Since gold is a good store of value, buying gold futures can offer your portfolio a hedge against inflation. Plus, gold futures trade easily because they are more liquid than gold ETFs. Thus, you can always liquify your futures easily when you need to quickly take advantage of an opportunity in the market.
Another benefit of gold futures is that they allow you to leverage. You can put some money into the contract at the time of entering the deal, and then complete the full amount on a later date  . This gives you flexibility on how and when the deal can be executed.
The biggest drawback of gold futures is that they can be volatile. Prices can fluctuate and expose your portfolio to risk. For this reason, it’s always wise to consider futures carefully before adding them to your pension plan or retirement account.
Which is better, gold future or gold ETF?
The differences between gold ETFs and gold futures relate to their costs, liquidity, leverage, margin and associated risk. By examining how they contrast, you may be able to determine which one makes a better investment vehicle for your portfolio.
While gold ETFs accrue management and marketing fees each day that a position is held, gold futures do not. These additional costs can affect gold ETF stock prices and have little to do with the actual price of gold. In this sense, futures are more cost effective.
Additionally, gold ETFs attract more taxes than gold futures. Part of the reason is because ETFs are treated as “collectible”. This means they are subject to taxation on large capital gains.
On the other hand, gold futures enjoy the 60/40 rule. In other words, only 40% of your gains are treated as short-term capital gains and taxed as ordinary income. The other 60% is treated as long-term gains and may enjoy a lower tax rate. As a result, a bigger chunk of your gold investment is taxed at a lower rate.
The market size of COMEX gold futures is 20 million ounces per day. That of SPDR gold ETF is much lower, and stands at 2.4 million ounces per day5.
Furthermore, the daily volume of COMEX gold futures is about $52 million. This is roughly 54 times the volume of SPDR gold ETFs4.
These numbers show that the gold futures market is a lot more liquid than SPDR gold ETFs. High liquidity is good for your portfolio because it allows you to easily enter and exit market positions. You can also dispose your gold easily and quickly to take advantage of a different market opportunity if/when it arises.
The best gold ETF accounts typically offer a maximum leverage of 3X. Gold futures push this value higher – up to 15X – to overshadow ETFs4.
A high leverage can be good because it allows you to take a great position without having to pay the full gold futures price. But it also exposes you to a higher risk level.
Therefore, if you want a vehicle that can allow you to open greater market positions, then it makes sense to opt for gold futures. On the other hand, if you want a stable portfolio (albeit with smaller gains), then gold ETF stocks make more sense.
Many gold futures quote low initial margins. It can dip as low as 3% of the entire contract value. In contrast, ETFs typically have higher margins of 50% plus broker fees4.
Thus, if you are working with little investment capital, it would be wiser to take advantage of the low margin that futures offer. But if you have a large kitty to work with, then ETFs may offer a less risky investment.
- Risk factor
Trading gold ETFs can expose you to additional risks that are not associated with gold prices. As an example, if the net asset value of the SPDR Gold Trust drops below $50 million, then it can liquidate4. This is not dependent on the price or value of gold. You don’t get such risks when trading gold futures.
Ultimately, gold ETFs present a safer yet costlier investment vehicle. Gold futures, on their part, are more affordable and offer higher liquidity.
Therefore, if you are going for a flexible portfolio that can allow you to open and close positions easily, then futures may be more ideal. But if liquidity is not a big deal, and your gains can offset the additional costs of ETFs, then you stand to enjoy the stability they bring. They are generally more suitable for long-term investments like pension plans and retirement accounts.