Value At Risk In GLD, GDX And NUGT

Includes: GDX, GLD, JNUG, NUGT
by: Viking Analytics


We graphically demonstrate the time decay in a triple leveraged ETF.

We discuss the volatility and risk in GLD, GDX and NUGT.

We introduce a simple approach to Value At Risk to evaluate gold ETF investments.


We are writing weekly updates on the SPDR Gold Trust (NYSEARCA:GLD), and occasional articles on other precious metal ETFs, including the VanEck Vectors Gold Miners (NYSEARCA:GDX) and the Direxion Daily Gold Miners Index Bull 3x Shares ETF (NYSEARCA:NUGT). In this article, we follow up on a concept of Value At Risk ("VAR") that we introduced in a prior article, and provide more background on why we believe that investors and traders should avoid NUGT and its little brother, the Direxion Daily Junior Gold Miners Index Bull 3x Shares (NYSEARCA:JNUG).

Triple Leveraged ETF Decay

First, as a quick follow-up to our recent article Trading NUGT and JNUG? Play Blackjack Instead, we will demonstrate how a triple leveraged ETF can lose significant value over time, even when the underlying ETF does not change in value.

Consider a fictitious 60-day period where an underlying ETF (such as GDX) instrument moves up 5% one day, then 4.76% down the next day, for a period of 60 days. Correspondingly, the triple leveraged ETF (such as NUGT) moves up 15% the first day, and down 14.3% the next day, for a period of 60 days.

At the end of 60 days, the underlying ETF still has 100% of its value; however, the value of the triple leveraged ETF has fallen to 65% of its original value. Unfortunately, for the long-term holder of the triple leveraged ETF, this is how the math works.

Direxion, the provider and administrator of NUGT and JNUG, even has a clear warning for investors on its website, a screenshot of which is shown below.

Source: Direxion

Admittedly, the 5% daily increase and decrease are higher than the normal daily price movement of GDX. If we were to assume the average daily price movement of GDX of 2% up and down, the loss in value for NUGT over the same 60-day period would be in the range of 7%. Over a 252-day trading period, the time decay for the same up and down movement would be 25%. It baffles us why anyone would willingly accept this time decay.

Volatility and Risk

In finance, the word "volatility" often is used to define the daily variation in price of a financial instrument. It is a statistical measure of financial risk. Over different time periods ending on April 5th, 2017, the annualized historical volatility of GLD, GDX and NUGT is tabulated below.

When one thinks of volatility and risk, the normal distribution curve - the "bell curve" - may come to mind. If we assume the time frame of 63 trading days (e.g. 3 months), the bell curve for GLD, GDX and NUGT can be seen below.

A one-standard deviation move in GLD would be 0.63% of its value. A one-standard deviation move for GDX and NUGT would be 2.1% and 6.3%, respectively, assuming the percentages in the above graph.

Value At Risk

We are sure that investors understand that JNUG has more price risk than GLD, and NUGT has triple the daily price risk of GDX. Nevertheless, we believe that if investors were to fully account for the risk involved in NUGT, then they might not chase its illusory rewards, especially in comparison to other alternatives.

Let's assume that an investor had $10,000 to trade at the end of 2016, and wants to decide between his options between GLD, GDX and NUGT. One thing that the trader could do is consider that a measure of Value At Risk is his point of stop loss, regardless of which ETF he chose to purchase.

If we assume those same volatilities as above, then the trader's VAR would be $1,000 for GLD, $3,400 for GDX, and $10,000 (all available capital) for NUGT. The table below compares the potential risk and reward of investing $10,000 in each of the three ETFs. February 8th represents the peak closing high value for NUGT in 2017.

On a nominal basis, the investor would have made $7,644 in NUGT by perfectly timing his sale on the highest closing peak. Nevertheless, we would contend that the risk-adjusted return of GLD was at least equivalent, because the volatility of GLD is so much lower than that of NUGT. The "risk adjusted return" we refer to is the dollar gain divided by the value at risk, highlighted in orange above.

At the end of March 2017, the three-month risk-adjusted return of GLD was much higher than both GDX and NUGT. Since NUGT has roughly 10X the variability and risk of GLD, then another way to evaluate this would be to consider a $1,000 investment in NUGT as equivalent to the $10,000 invested in GLD. In that case, in the 3-month period ending March 31st, the GLD investment would have earned $831 and the NUGT would have earned $177.

These examples are intended to be illustrative. There are different ways to calculate VAR and consider risk-adjusted returns. We attempted to present a relatively simple example here to help gold investors think more about the risk that they are taking before they hit the "buy" button, especially on the triple leveraged ETFs.

All tables and graphs are by Viking Analytics unless otherwise indicated. If you found this article helpful, please hit the "Follow" button above. Good luck!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.