Are leveraged gold bull ETFs (Exchange Traded Funds) really investment vehicles for those seeking to hold gold?
We will be using SPDR Gold Shares ETF (GLD) as the basis of comparison, as this previous article concluded that gold bullion ETFs are the best-performing gold investments. Subsequent reader questions and my Instablog response about a 3x gold miner bull (NUGT) identified that this ETF underperformed the commodity ETF and the other alternatives.
The remaining question about which gold investment type (CEF, ETF, or miner) is: How, which, and when to use gold leveraged ETFs? I am only considering the gold ETFs with long positions, although the conclusions could be extrapolated to those with double and triple-short positions. If you are specifically interested in leveraged short gold ETFs and ETNs, you should read this article: A Guide To Inverse Gold ETFs And ETNs. I used the ETF section of Stock-Encyclopedia.com to identify the gold bull ETFs.
It seems that only a certain segment of gold investors are interested in leveraged gold bull investments. As a basis for comparison, the SPDR Gold Shares ETF, with $75B market capitalization, has 17,135 people receiving SA email alerts. The corresponding statistics for each of the alternatives are included in the table, below.
First, let's examine the composition/goals of these securities. Please note that the first five are U.S. traded securities (the other three in the table, from Canada and the UK, are for informational purposes only - they are very similar to the U.S. double bulls, but are not traded OTC in the U.S.). I included the ProShares Ultra Silver ETF (AGQ) in order to see if it behaves the same way as its gold counterparts:
Company / Fund (Ticker)
# SA Followers
Direxion Daily Gold Miners Bull 3x Shares ETF
The Daily Gold Miners Bull 3x shares seeks daily investment results, before fees and expenses, of 300% of the performance of the NYSE Arca GoldMiners Index ("Gold Miners Index"). The NYSE Arca Gold Miners Index is comprised of publicly traded companies that operate globally in both developed and emerging markets, and are involved primarily in the mining for gold and silver. One cannot directly invest in an index.
FactorShares 2X Gold Bull/S&P 500 Bear ETF (FSG)
FactorShares 2X: Gold Bull/S&P500 Bear is a leveraged spread ETF designed for investors who believe gold will increase in value relative to large-cap U.S. equities in one day or less. FSG seeks to track approximately 200% of the daily return of the S&P Gold - Equity Spread Total Return Index (before fees and expenses) by primarily establishing a leveraged long position in Gold Futures and a leveraged short position in the E-mini S&P 500 Stock Price Index Futures.
PowerShares DB Gold Double Long ETN (DGP)
The PowerShares DB Gold Fund is based on the Deutsche Bank Liquid Commodity Index - Optimum Yield Gold Excess Return and managed by DB Commodity Services LLC. The Index is a rules-based index composed of futures contracts on gold and is intended to reflect the performance of gold.
ProShares Ultra Gold ETF (UGL)
ProShares Ultra Gold seeks daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of gold bullion as measured by the U.S. Dollar p.m. fixing price for delivery in London. The Funds do not directly or physically hold the underlying gold, but instead, seek exposure to gold through the use of Financial Instruments (primarily exchange-traded futures contracts and over-the-counter forward contracts) whose value is based on the underlying price of gold to pursue their investment objective. The benchmark price of gold is the U.S. Dollar price of gold bullion as measured by the London afternoon fixing price per troy ounce of unallocated gold bullion for delivery in London through a member of the London Bullion Market Association.
ProShares Ultra Silver ETF
ProShares Ultra Silver seeks daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of silver bullion as measured by the U.S. Dollar fixing price for delivery in London. The Funds do not directly or physically hold the underlying silver, but instead seek exposure to silver through the use of Financial Instruments whose value is based on the underlying price of silver to pursue their investment objective. The benchmark price of silver is the U.S. Dollar price of silver bullion as measured by the London fixing price per troy ounce of unallocated silver bullion for delivery in London through a member of the LBMA authorized to effect such delivery.
Horizons BetaPro COMEX Gold Bullion Bull Plus ETF (HBU-TSX)
N/A - TSX
The HBP COMEX® Gold Bull + ETF seeks daily investment results, before fees, expenses, distributions, brokerage commissions and other transaction costs, that endeavor to correspond to two times (200%) the daily performance of the COMEX® gold futures contract for the next delivery month. The HBP COMEX® Gold Bull + ETF is denominated in Canadian dollars. Any U.S. dollar gains or losses as a result of the fund's investment will be hedged back to the Canadian dollar to the best of its ability.
Horizons BetaPro S&P/TSX Global Gold Bull Plus ETF (HGU-TSX)
N/A - TSX
The HBP Gold Bull+ ETF seeks daily investment results, before fees, expenses, distributions, brokerage commissions and other transaction costs that endeavor to correspond to two times (200%) the daily performance of the S&P/TSX Global Gold Index.
ETFS Leveraged Gold ETF (LBUL-LSE)
N/A - LSE
ETFS Leveraged Gold is an Exchange Traded Commodity (ETC) which is UCITS eligible. It will provide a total return equal to two times (2x) the daily change in the Dow Jones-UBS Gold Excess Return Index plus a collateral yield. Investors can gain twice as much from a rise in the underlying index.
As a first step, I examined what the sponsor had to say about their leveraged bull gold funds. I have decided to use the Direxion Funds as a representative example:
You know that TRADING is different than investing. But the opportunity to take advantage of short-term trends is only won, if you get the direction right.
... Leveraged ETFs are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk, consequences of seeking daily leveraged investment results and intend to actively monitor and manage their investments. Leverage ETFs are not designed to track the underlying index over periods longer than one trading day.
The prospectus for the Direxion Daily Gold Miners Bull 3x Shares ETF provides a lengthy description of the product and risks. Here is a small section which summarizes their key points:
(3) The Funds seek daily leveraged investment results. The pursuit of these investment goals means that the return of a Fund for a period longer than a full trading day will be the product of the series of daily leveraged returns for each trading day during the relevant period. As a consequence, especially in periods of market volatility, the path of the benchmark during the longer period may be at least as important to a Fund's return for the longer period as the cumulative return of the benchmark for the relevant longer period. Further, the return for investors that invest for periods less than a full trading day or for a period different than a trading day will not be the product of the return of the Fund's stated goal and the performance of the target index for the full trading day. The Funds are not suitable for all investors.
The Funds are designed to be utilized only by sophisticated investors, such as traders and active investors employing dynamic strategies. Such investors are expected to monitor and manage their portfolios frequently. Investors in the Funds should:
a. understand the risks associated with the use of leverage,
b. understand the consequences of seeking daily leveraged investment results,
c. understand the risk of shorting, and
d. intend to actively monitor and manage their investments.
Investors who do not understand the Funds or do not intend to actively manage their funds and monitor their investments should not buy the Funds. There is no assurance that any of the Funds offered in this prospectus will achieve their objectives and an investment in a Fund could lose money. No single Fund is a complete investment program.
If a Fund's underlying benchmark moves more than 33% on a given trading day in a direction adverse to the Fund, the Fund's investors would lose all of their money.
In other words, the daily rebalancing to buy three times the number of forward contracts on the portfolio positions will consume part of the underlying capital. If you buy the bull position, and gold plummets 33% (as this is leveraged 300%) during your holding period, your position will be worth zero. Direxion lengthily explains that this is NOT a long-term investment - in fact, it is a one-day trade (or at most, a few days). It appears that the investor must anticipate a price spike, buy, and then sell immediately (within a few days at most), to make money.
The opportunity for leverage is to magnify your gain over a short term trade. The challenge is that if you do not accurately guess the short-term market direction, or choose to hold the leveraged security for longer than the trading day that you purchased the leveraged-fund, your capital is consumed by the rebalancing of the contracts, regardless of whether the investment is the leveraged commodity or the miners.
Let's benchmark these securities against each other and SPDR Gold Shares ETF to see the short-term and long-term performance, Graphs are courtesy of CIBC Investors Edge.
The following chart shows the five-year performance of a gold bullion fund relative to the leveraged commodity funds. The relatively-flat purple line is the price of gold bullion (represented by GLD). The leveraged gold funds - DGP (heavy gold line) and UGL (top brown line) - have identical trend-lines. These leveraged funds follow the trend lines of the commodity, with the expected higher volatility - exaggerated highs and lows as they are leveraged plays. (click to enlarge)
FSG (the blue line) has a slightly different behavior, as it also invests in a leveraged short position in the E-mini S&P 500 Stock Price Index Futures. The other two gold leveraged funds have higher highs and lower lows than the commodity, unleveraged fund.
The ETF websites specifically explain that these leveraged bull ETFs are for very brief holding periods - perhaps hours or a few days. Let's take a look at the short-term (ten-day) trend and volatility of the same four securities. Although the leveraged funds follow the trend lines of the commodity (with the expected higher volatility), FSG (the blue line) with its leveraged short position in the E-mini S&P 500 Stock Price Index Futures, seems to be disconnected from the gold commodity price.
Therefore, if you want to use leveraged funds to enhance your return and risk on gold investments, FSG - with its non-gold attributes - will not provide you alignment with the gold commodity price.
The next question is whether silver and/or gold mining leveraged ETFs will track, under-perform, or out-perform gold bullion. The next graph is a five-year trend for a silver commodity and a gold mining leveraged ETF, compared to GLD (gold bullion).
The following chart shows silver as the long-term winner (top line). Again, the relatively-flat purple line is the price of gold bullion (represented by GLD), with the leveraged gold-miner ETF as the under-performer. The conclusion is that for leveraged funds, neither a silver holding nor a gold miner fund will consistently align with the behavior of a gold commodity fund. Therefore, these (at least for leveraged funds) are not good gold-substitutes.
Let's, again, compare the short-term (ten-day) trend and volatility of the same four securities. Although I am not a technical analyst, I do not see a specific alignment of the trend-lines, and for the time-frames that they may be comparable, one cannot know whether there are other contributing market factors given the very short sample period.
Therefore, I assume that the variances of these leveraged ETFs to the price of gold can be explained by:
- Silver: AGQ is the heavy-gold line. It seems to behave independently of gold (the thin-purple line) on both charts.
- Gold Miners: At least for leveraged ETFs, and for the short-term, miners do not reflect the movement in the price of gold - Direxion Daily Gold Miners Bull 3x Shares ETF is the thin-gold line.
- Leveraged ETFs are for very short-term traders; not investors.
- Leveraged gold bullion funds will track the movement of gold bullion, with volatility multiplied by the leverage. PowerShares DB Gold Double Long ETN and ProShares Ultra Gold ETF will provide these results.
- FactorShares 2X Gold Bull/S&P 500 Bear ETF does vary with gold, but as it includes other (non-gold, market-short) positions, it appears to have investment objectives that are somewhat different from simply holding leveraged gold - it is a play on the stock market dropping.
- Gold mining leveraged ETFs do not appear to track gold prices in the short-term and may under-perform the comparable commodity funds in the longer-term. Given that these leveraged investment vehicles are very short-term holds, they may not be an effective gold-investment substitute.
- Silver is a commodity that seems to behave independently of gold. It may be a "poor man's gold" (silver has often been called "poor man's gold" because it is more affordable - for example, around $1,730 for gold and $33 for silver per troy ounce), but we have seen that the silver leveraged fund will not track its gold counterpart.
If you want to buy a leveraged gold fund for a short-term trade, buy a leveraged gold fund to achieve this goal - the other alternatives may not meet your objectives. For longer term gold holdings, leveraged funds are not an appropriate choice.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.