The Direxion Shares Exchange Traded Fund Trust (NUGT), a 3x levered gold miners index, has had a wild ride to start 2016. NUGT uses leverage to achieve roughly three times the daily return of the VanEck Vectors Gold Miners ETF (GDX). The underlying gold miners ETF has doubled off its 52-week low, spiking from $12 to $24 per share. NUGT stock has exceeded that to a large degree; it’s up from a low around $17 to about $100 per share today.
After going up sixfold, there’s good reason to wonder whether the rally in NUGT stock can continue. Big gains are exciting, but what comes easily can often go equally quickly. Is there still time to profit from NUGT stock, or is now a good time to step aside?
NUGT Stock: Pros
Gold Turns The Corner: Since gold topped at $1,900/oz, it’s been a long slow slog to the downside. Gold has steadily fallen over the years, eroding hopes of a quick recovery. Many prominent fans of gold threw in the towel in 2015, suggesting that maybe the gold bear would last longer than they had expected. Sure enough, when the mood turns negative enough, then a bottom can occur. Momentum quickly shifted toward the end of 2015.
Since gold’s most recent low around $1,050/oz, gold has spiked higher. It’s surged to almost $1,300/oz in short order, a more than 20% move off the low. It’s been one of the biggest moves higher in gold since the top was reached almost five years ago. There’s no guarantee that gold is finally done falling, but the odds look increasingly good the longer and farther this rally goes.
Obviously, the rally has been extremely good for NUGT stock, and if this rally has legs it could continue.
Lean and Mean: Gold miners badly overexpanded during the gold boom that ran for a full decade to start the 2000s. Gold ran from $300 per ounce to $1,900, making any companies that weren’t aggressive look foolish. By the end of it, companies were eagerly forking over billions on mines with questionable economic prospects. The higher price of gold cured all potential ills, for awhile. Many companies also quit hedging the price of gold, betting that ever-higher prices would add to their bottom lines.
This over-aggressiveness cost the industry dearly, and it would be reflected in the NUGT stock price in the down years.
Dozens of mines have been idled, and numerous smaller players have gone bankrupt or been forced to sell for pennies on the dollar. The cost of producing an ounce of gold, which had surged to as high as $1,400/oz at many firms during the top of the boom is now broadly back under $1,000/oz. Until about 2014, the miners continued to act as though a return to prosperity was just around the corner. But the deeper and more painful cuts over the past two years finally have the industry back to a point where a rise in gold prices will translate to large jumps in profitability, offering investors the prospects of dividends or share buybacks that have long been largely absent.
No doubt this is one of the reasons NUGT stock’s recent rise has been so relentless.
Great Returns After Industry Crashes: The gold mining industry has been utterly devastated over the past few years. The industry ETF, GDX, fell from $65 to the low teens, an 80% drop, since 2011.
According to data from financial blogger Meb Faber, on average, after an industry falls 80%, over the next three years, investors can expect average returns of 136%. As of now, gold miners are up roughly 95% from the bottom, suggesting that while much of the move has already occurred, that on average, there’s still more upside to come as the gold market potentially enters a prolonged recovery.
If true, that could be a huge boost to NUGT stock.
NUGT Stock Cons
It’s a Levered ETF: Leveraged ETFs can be excellent tools for playing short-term moves in the price of an asset. If you’re trying to catch a move that lasts a couple days, a 3x levered ETF could be the right way to play. But as long-term investments, 3x ETFs give horrendous results.
This is due to the daily rebalancing feature of these ETFs that forces them to adjust their exposure to 300% of the underlying ETF, in this case, GDX. After a big upmove, NUGT stock won’t have enough exposure supporting it. So NUGT must buy more gold miners after a big rally. Similarly, when gold miners decline, then NUGT stock has too much exposure to the miners. So following a decline, NUGT has to unload miners to rebalance. This is an ETF literally designed to buy high and sell low.
The long-term results of the 3x ETFs have been terrible. Over the past year, for example, GDX is up 25%. With the industry up 25%, you’d expect NUGT to have a big gain, and the Direxion Daily Gold Miners Bear ETF (DUST) to have a big loss. DUST stock has done its part, it’s down 91%, losing even more than 3x what the gold miners did. However NUGT stock is down fractionally over the past year, not up at all despite the 25% rise in gold miners. Since 2011, NUGT has fallen from more than $210,000 per share (split-adjusted) to $100 today. DUST, for its part is down from $20 per share to under $2 today. That. Is. Awful.
Gold Running Into Resistance: $1,300/oz is a key line in the sand. Gold rallies have petered out before after 20% jumps. And $1,300/oz is still below the last run-up. If gold falls from this level, technical analysts would suggest that it was a bearish development for gold and recommend shorting. NUGT stock would perform horribly.
Above $1,400/oz, it’d be fairly clear that gold was in fact in a new bull market. Even a sustained rally to the mid-$1,300s would convince a lot of skeptics. But a failure here from this point would be very bearish. For another run higher in miners, you need gold to push through the resistance at $1,300.
Weak Yield: While holders of NUGT stock probably aren’t expecting a sizable dividend from their investment, the owners of the underlying gold miners ETF, GDX, do care about such things. The doubling of GDX stock necessarily causes the yield to be halved. With many of the mining firms unprofitable in recent years, dividends were already slashed, and now yields are dropping further.
At this point, the gold miners yield just 0.5% as an industry. For investors looking for growth and income, a figure that low surely rules out the industry. The move higher in gold is helpful. But for investors waiting to see attractive P/Es and stronger dividends from their gold mining holdings, the industry is still unattractive. This could change after a few more quarters of stronger operating results, but for now, it’s a headwind.
NUGT Stock: Verdict
I would never buy NUGT stock as a long-term investment. The performance since its launch in 2011 is staggeringly bad. If you are going to buy NUGT stock, please do so as a short-term trade, and get out at the first sign of trouble. More generally, the gold miners have a lot going right, and I can see a solid case for buying GDX. But I’d wait for a correction first, as the move up over the past few weeks seems to be overblown.
At the time of this writing, Ian Bezek held a short position via put options in NUGT stock. He can be reached on Twitter at @irbezek.
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