JDST - JDST Is An Aggressive Play On More Yield Curve Shifts

Summary

• JDST is a levered play against gold miners, and therefore a play against gold prices.
• Yield curves shifting up support fiat over gold, and that could mean upward movements in JDST if the heavy-handed hawkishness persists.
• Higher rate expectations could mean money markets become preferable, and then long-duration instruments at a speculated peak, if the tenor and distance of rate hikes become more predictable.
• While there are structural forces in favor of JDST, be careful with leveraged ETFs, there are many risks inherent to the instrument.

The Direxion Daily Junior Gold Miners Index Bear -2X Shares ( JDST ) is a way to play against an index of gold miners and therefore against the gold price. There are dangers inherent to these sorts of ETFs, but we think that structural elements could play in favor of JDST related to higher rates and incentive to speculate on money market funds and longer duration around the rate hikes, rather than on non-productive gold assets. Still, because of risks on timing, these sorts of instruments need to be taken with great caution, and speculators should consider waiting for major CPI dates before acting.

Leveraged ETFs Have Risks!

Leveraged ETFs have risks. Because they reset daily after mimicking changes in the index that day by a 2x factor in the case of JDST, there is the problem of value erosion. While a 1% rebound after a 3% drop isn't so bad for the underlying index, having a 6% drop and a 2% rebound is more of a problem. There is a reason why Warren Buffett's #1 rule is, don't lose money. If you lose money, you have less to recover with, meaning for every drop you need a bigger percentage recovery to bring you back to square 1. If an asset drops 33%, you need an almost 50% recovery to recover. If an asset drops 50%, you need 100% recovery to breakeven. Even if the next day is a bigger rebound than what you lost the previous day, with leveraged ETFs it is still less helpful even if the recovery gets doubled because more money was lost the prior day.

If you don't fully understand these risks, do not proceed with a leveraged ETF. They are best used over short durations because of value erosion. They are highly speculative burst instruments.

Links for reference on these risks:

The Lowdown on Leveraged and Inverse Exchange-Traded Products

Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors

Regulatory Notice 09-31 | FINRA.org

Thesis

Still, there are structural forces that do support a bearish bet against gold right now. With rates continuing higher according to a hawkish Fed , gold becomes less attractive than fiat. The reason why there are structural forces is that the Fed must be heavy-handed in its dealing with inflation. Not only have shorter duration rates gone up, but the yield curve has translated up maintaining a pretty similar shape, meaning longer-term rates are higher too. This makes fiat durably more interesting than gold in the respect of providing direct return, which gold doesn't.

This reflects the structural nature of the higher rates that the Fed is likely going to impose for a longer while to deal definitively with inflation at the expense of the economy. The reason for this has to do with the wage-price spiral. Consumer expectations of inflation are still low, which is good for those hoping for a shorter rate cycle, but because inflation staying higher than the desirable 2% level even for a little while could change that, the Fed won't bat an eye to a choked economy. We still think that the US economy will show resolve, but also think rates will come in higher and that could be the main pressure on gold prices, which could pay off in a JDST position.

Moreover, gold prices have held quite highly as is, likely absorbing some funds from a risk-off attitude . Much of the risk-off attitude is pricing in continued pain in the market, but a sustained higher rate in a more anticipated rate cycle would be bad for gold due to fiat currencies' ability to return capital and speculate on both upticks in rates as well as on potential peaks. The generally elevated gold price right now near local highs could be good for the bear bet of JDST.

Bottom Line

Around mid-March is when the Fed meetings are going to happen again. Since leveraged ETFs are better in bursts and for shorter periods, those are the dates that speculators should remember.

However, JDST speculators should be aware of the risks to the rate thesis, which is that the post-invasion figures are about to be lapped. Inflation is going to ease further in our opinion, and if it comes down more than expected as the supply chain shocks get baked into the base effects, there may be less concern by markets on rates and less new speculation on where the peak in rates will be. Gold may become more interesting again and hurt JDST values - although a mitigating factor is risk-on sentiment will probably limit how much gold could rise.

But if rates grow further as is now expected, and markets get comfortable again with a new regime of rate hiking, gold prices could indeed fall on both an increased certainty about the tenor and distance of the rate hikes meaning less risk-off positioning, but also the betting on fixed income instruments rather than gold as people speculate on money markets for further upticks in rates, and on longer duration instruments when speculating on a potential rate peak for income plays.

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