[Editor’s note: “The Best (And Worst) Part of Trading Gold ETFs” was previously published in August 2016. It has since been updated to include the most relevant information available.]
Talk about extremes! The Direxion Daily Jr. Gold Miners Bull 3X ETF (NYSEARCA:JNUG) and Direxion Daily Gold Miners Bull 3X ETF (NYSEARCA:NUGT) and Direxion Daily Gold Miners Bear 3X ETF (NYSEARCA:DUST) all made amazing gains this week as investors sought safety in this uncertain market.
For those who made the right call on gold prices, it’s reason to celebrate. For those who sat on the wrong side of the table though, today’s instantaneous losses are downright painful.
To those traders experienced with the leveraged ETFs like DUST and JNUG, the disparate results aren’t unheard of, even if today’s extreme action isn’t the norm. To those traders who’ve not dealt with the likes of NUGT and JNUG, however, a day like today could turn them off of the idea of leveraged funds forever.
Thing is, while leveraged funds are volatile by design, the gold-centric ETFs are in a category of their own, and should be viewed in a different light than their close cousins.
More Leverage Than Most Traders Need
For the unfamiliar, the aforementioned funds with the Direxion family (the Gold Miners Bull 3X ETF, the Jr. Gold Miners Bull 3X ETF and the Gold Miners Bear 3X ETF) are a special breed. Whatever those funds’ holdings do, the funds do it three times as much … for better or worse.
The pop in the price of gold mining stocks is, however, good news for ETFs like the Direxion Daily Gold Miners Bear 3X ETF; DUST is up big-time today.
That is the point, of course — traders are looking to turn a relatively small move into a relatively large move. They require one to be “right” about a stance, but the payoff is clearly market-beating when collected.
Even the occasional wrong call on leveraged gold mining ETFs, though, may make them riskier than they’re worth for most would-be users.
While most traders have gotten comfortable with the idea of the volatility inherent with leveraged ETFs, many of those same traders have largely overlooked the idea that gold mining stocks are already inherently leveraged.
It has to do with the cost of operating a gold mine. There are fixed costs for every ounce of gold dug up: mining rights, fuel expenses, payroll, equipment leases, etc. These are more or less the same regardless of the price of gold, and for most miners, the average total cost to mine gold in 2019 was $1,000 per ounce.
That was true when gold was trading at $1,400 per ounce on March 16, and it was true when gold was trading at $1700 per ounce on April 22.
And it’s from that vantage point traders have an “aha” moment — every dollar-per-ounce gold moves above $1,200 is nearly a full dollar improvement on per-ounce margins. Net profit margins can rise very quickly for miners with just a small lift in the price of gold, as (unlike other industries) there are no major additional costs for a miner to produce more gold.
It works the other way too, though. A small downward move from gold — say from $1,225 per ounce to $1,175 per ounce — can cause a sizeable swing to operating losses. After all, fixed costs are fixed costs.
Obviously those costs vary from miner to miner and can fluctuate from year to year. They don’t vary a great deal, however, setting up wide swings in profitability and corresponding wide swings in the price of gold mining stocks. Leveraged gold mining ETFs magnify the impact of already-highly-leveraged gold mining profits.
Bottom Line for JNUG, NUGT and DUST
None of this is to say tickers like NUGT, JNUG and DUST should be avoided. They can and do serve a purpose, if for no other reason than hedging, which likely is why they got so much action recently.
It is to say, however, they’re even more leveraged than the 3X descriptor may suggest, as they reflect the volatility of stocks that are already quite leveraged on their own.
If you can stomach the wild swings and the occasional inevitable loss, go for it. Just don’t fool yourself into thinking you can make a quick escape if things go sour. These instruments move fast, and many traders find themselves behind the proverbial eight-ball before they even realize what’s happened.
Ironically, the lower-risk and more palatable way to play gold is by trading options on the SPDR Gold Trust (NYSEARCA:GLD).
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.