Commodity ETF Arbitrage: Futures-Backed versus Physical-Backed ETFs

The commodity ETF market has reached an equilibrium where most precious-metal ETFs are backed with physical assets, while other commodity ETFs tend to be backed with futures contracts. In this study, we consider the impact that these two different approaches have on the built-in arbitrage mechanism for ETFs, and find that the arbitrage mechanism for physical-backed ETFs works better. Futures-backed ETFs are smaller and less liquid, which we find contributes to the decreased arbitrage activity. We speculate that the significantly higher fees for futures-backed ETFs contribute to the lack of scale necessary to maintain close tracking of the ETF net asset value through arbitrage.