NUGT - NUGT: Leverage And Compounding Has Made This Gold Miners 2x ETF Unattractive

2023-06-12 04:57:54 ET

Summary

• Gold production is higher than gold consumption, which might be a reason for gold prices not skyrocketing, despite the current uncertain economic scenario.
• Even if gold prices go up, NUGT may not be the best option to capture it due to the complexities involved and extreme volatilities inherent in a leveraged ETF.
• Due to effects of compounding, over a period of time, there can be startling differences between the performance of benchmark and that of leveraged ETF.
• Inverse & leveraged ETFs are reset on a daily basis and are unsuitable for retail investors who plan to hold them for long term, particularly in volatile markets.

~ by Snehasish Chaudhuri, MBA (Finance)

During my last coverage almost a year ago, I was hopeful that Direxion Daily Gold Miners Index Bull 2x Shares ETF ( NUGT ) will perform better than that of previous year. Certain geo-political events, such as unfavorable weather, pandemic-related disruptions, and Russian invasion of Ukraine resulted in a shortage of supply throughout the globe, and the supply chain breakdown further reduced the supplies and sent commodity prices higher. I was expecting that funds involving equity of gold mining companies, energy and commodities to be positively impacted by those events, and thus was optimistic about their growth potentials. I was hopeful that people will invest more in gold in order to protect their capitals under a seemingly uncertain economic scenario. Let's see, what actually happened during the past 1 year.

NUGT's investment moves 2x upwards or downwards with respect to its Benchmark

Direxion Daily Gold Miners Index Bull 2x Shares ETF is an exchange traded fund that seeks to track 2x the daily performance of the NYSE Arca Gold Miners Index ( GDMNTR ), that constitutes publicly traded companies which are involved primarily in mining gold and silver. NUGT's investment moves 2x upwards or downwards with respect to the GDMNTR. NUGT invests in futures and swaps of those stocks in both developed and emerging public equity markets around the globe. Almost 47.5 percent of its investments are in the equity markets of Canada, whereas the US and Australian equity markets hold almost 15 percent each of the total assets under management of NUGT.

NUGT Benchmarks GDMNTR, and Invests Majority of Its Assets in GDX

NUGT invests more than 51 percent of its assets in VanEck Gold Miners ETF ( GDX ), and the major stocks held by GDX includes Newmont Corporation ( NEM ), Franco-Nevada Corp. ( FNV ), Barrick Gold Corp. ( GOLD ), Agnico Eagle Mines Limited ( AEM ), Wheaton Precious Metals Corp. ( WPM ), Newcrest Mining Limited ( OTCPK:NCMGF ), Gold Fields Limited ( GFI ), AngloGold Ashanti Ltd. ( OTCPK:AULDF ), Northern Star Resources Ltd. ( OTCPK:NESRF ), Royal Gold, Inc. ( RGLD ), Zijin Mining Group Company Limited ( OTCPK:ZIJMF ), Kinross Gold Corporation ( KGC ), Endeavour Mining plc ( OTCQX:EDVMF ), Alamos Gold Inc. ( AGI ) Pan American Silver Corp. ( PAAS ), Evolution Mining Limited ( OTCPK:CAHPF ), Zhaojin Mining Industry Co Ltd. ADR ( OTCPK:ZHAOY ), B2Gold Corp. ( BTG ), Hecla Mining Company ( HL ), Osisko Gold Royalties Ltd ( OR ) and Harmony Gold Mining Company Limited ( HMY ).

Due to Leverage, NUGT Failed to Generate Returns During the Past One Year

Together these 21 stocks constitute almost 85 percent of GDX. Not surprisingly, most of these stocks generated positive price growth during the past 12 months. Only four stocks - NEM, GOLD, PASS and EVN failed to achieve positive price growth. On the other hand stocks like GFI, AULDF, NESRF, AGI, ZHAOY, OR and HMY - generated high price growth - in between 40 to 70 percent. Thus, overall, the constituent stocks had a strong price performance during the past one year. However, the price growth of Direxion Daily Gold Miners Index Bull 2x Shares has been really disappointing with a negative growth of 20.44 percent. This is not surprising, due to the leveraged nature of this fund. Perhaps, the number of days in which prices of these stocks fell has been much higher than the number of days the prices rose. And due to 2x investments and power of compounding, NUGT failed to capture the positive price growth of the majority of its component stocks.

Even if Gold Prices Go Up, NUGT Is Not The Best Option to Capture Such Benefits

Direxion Daily Gold Miners Index Bull 2x Shares is a two-times leveraged gold mining ETF. There are some supportive factors, like the purchase of gold by central banks and positive sentiment regarding precious metals. However, gold production is higher than gold consumption, which might be a major reason gold prices are not skyrocketing, considering the uncertain economic scenario we are going through. Gold didn’t rally despite favorable factors like inflation and war in 2021, 2022 and first half of 2023. I am not confident that gold will shine in the remaining half of 2023, either. Even if gold prices go up, NUGT may not be the best option to capture higher gold prices due to the complexities involved and extreme volatilities inherent in a leveraged ETF.

Risks

Due to Beta Slippage, Leveraged Equity Funds are not suitable for long term investments. NUGT’s daily 2X leverage factor on the Dow Jones is a source of drift. This happens primarily because the percentage change in the value of a leveraged ETF is much more than the percentage change in its benchmark index. Suppose an index or unleveraged fund goes up by 25 percent one day and then falls by down 20 percent the next day. A 2x leveraged ETF will then go up by 50 percent the first day and fall by 40 percent the next day. Thus, the index will have the same value as it had initially. But, the 2x leveraged ETF will become 90 percent of its original value. This is commonly known as beta-slippage. GDX (the fund in which more than 51 percent of NUGT’s assets are invested) generated a return of 1.66 percent during the past one year. NUGT’s return for the same period was negative 15.68 percent. Under such a scenario, NUGT will have a drift of negative 5.72 percent. Beta slippage is a major concern if any investor plans to hold this leveraged ETF for a long term.

Drift of NUGT w.r.t GDX thus will be ( -15.68% - 1.66%x2))/1.66%x2 = -5.72%

ETF Sponsor's Note on NUGT and (DUST): These leveraged ETFs seek a return that is 200% or -200% of the return of their benchmark index for a single day. The funds should not be expected to provide two times or negative two times the return of the benchmark’s cumulative return for periods greater than a day.

NUGT is neither a Good Option for Income-Seeking nor Growth-Seeking Investors

While gold is considered a good hedge in uncertain times, buying gold mining stocks is considered riskier than holding physical gold. Leveraged ETFs on the other hand, are designed to achieve certain objectives on a day-to-day basis. Over a longer period of time, there can be stark differences between the performance of benchmark index and the performance of leveraged ETF. This happens primarily due to the effects of compounding. Inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for long term, particularly in volatile markets. Due to absence of dividend, income seeking investors will hardly find any merit in investing in this 2x leveraged ETF. In my opinion, Direxion Daily Gold Miners Index Bull 2x Shares is not an ideal investment option for growth seeking investors either.

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