UGL - UGL: Leveraged Exposure To Gold In Times Of Economic Uncertainty

2023-03-17 03:01:50 ET

Summary

• The ProShares Ultra Gold ETF has jumped by nearly 40% from its October 2022 low.
• A banking crisis in the United States could lead investors to seek safe haven assets like gold, which historically has been viewed as a hedge against economic uncertainty.
• UGL provides leveraged exposure to gold, potentially allowing investors to increase their returns in a rising gold market.
• However, it's important to carefully consider the risks before investing in UGL or any other leveraged ETF. Most notably its expense ratio of 0.95% could reduce returns over time.

Thesis

In the event of a banking crisis in the United States, there may be economic uncertainty, causing investors to seek out safe haven assets like gold. This has been demonstrated in past crises, such as the Great Financial Crisis in 2008 and the Savings and Loans Crisis in the late 1980s and early 1990s. Gold is often viewed as a store of value and a hedge against inflation, which typically increases during times of crisis. As a result, investing in the ProShares Ultra Gold ETF ( UGL ), which provides leveraged exposure to gold, may present an appealing opportunity for those looking to profit from a potential increase in spot gold prices. However, it's important for investors to carefully consider the risks before jumping in UGL due to the leveraged used. As Charlie Munger said, "Smart men go broke three ways - liquor, ladies and leverage". Interestingly, Munger admitted to employing a modest amount of leverage despite his cautionary words.

ProShares Ultra Gold ETF: Leveraged Exposure to Gold with Potential for Amplified Returns

ProShares Ultra Gold ETF is an exchange-traded fund that aims to provide investors with leveraged exposure to the price of gold. The fund uses financial derivatives such as futures and swaps to achieve this objective, potentially allowing investors to increase their returns in a rising gold market. Specifically, the ETF seeks to provide twice the daily return of the benchmark gold price, as measured by the London PM Fix Price. However, it's important to understand that leveraged ETFs like ProShares Ultra Gold are not suitable for all investors. They are usually designed for short-term trading and can be highly volatile, which means that investors could experience significant losses if the market moves against them.

ProShares Ultra Gold ETF Expense Ratio: Is 0.95% Competitive for Your Investment Strategy?

The expense ratio for ProShares Ultra Gold ETF was 0.95%. This implies that for every $1,000 invested in the fund, $9.50 would be used to cover the fund's operating expenses every year. While UGL is more expensive than other gold ETFs like iShares Gold Trust, SPDR Gold Shares, and Aberdeen Standard Physical Gold Shares ETF, comparing UGL to other funds that invest in gold can be challenging because UGL uses leverage, while the other funds do not.

Banking Crisis in US Could Boost UGL Investment Potential

If a banking crisis were to occur in the United States, it would lead to economic uncertainty and potentially drive investors towards gold, which historically has been viewed as a safe haven asset. During times of crisis, investors tend to seek out assets that are perceived as a store of value and a hedge against economic uncertainty, with gold being one such asset. During the 2008 financial crisis, for instance, gold prices increased significantly as investors sought safety amid market turmoil. From the beginning of 2008 to the end of that year, gold prices rose by over 4%, while the S&P 500 index declined by more than 38%. However, price dynamics are not always straightforward and gold prices can experience temporary declines at the start of a panic. One reason for this is that investors may receive margin calls on their other investments, leading them to sell their gold holdings since it is a highly liquid asset.

There are other historical examples of banking crises leading to a rise in gold prices, such as during the Savings and Loans Crisis of the late 1980s and early 1990s. During this period, gold prices increased by over 7% from early 1989 to late 1990. Moreover, there is a perception that gold prices tend to increase during times of high inflation, which can often be a symptom of a banking crisis. This is because gold is viewed as a hedge against inflation, with its value often rising when inflation erodes the value of paper currency. For example, during the inflationary period of the 1970s, gold prices increased from around $35 per ounce in 1970 to over $600 per ounce by the end of the decade.

In the past, we have observed that following yield curve inversions in the United States, gold tends to outperform the S&P 500. As a quick refresher, the Treasury yield curve inverted in July of 2022. As a result, gold has been outpacing US equities since that time.

The ratio of gold to the S&P 500's performance at present is closely following the historical average performance during times when the percentage of inversions in the US Treasury curve surpassed 70%. This dynamic is depicted in an excellent chart from Crescat Capital LLC.

Given these potential scenarios, UGL, which provides leveraged exposure to gold, could be an attractive investment opportunity for those looking to capitalize on a potential increase in gold prices.

Understanding the Risks of ProShares Ultra Gold ETF: Leveraged ETFs and Expense Ratios to Consider

It is vital to remember that risks accompany investments in UGL, as with any other investment. Leveraged ETFs like UGL are generally intended for short-term trading and may not suit all investors. Moreover, UGL's 0.95% expense ratio could curtail returns over time if held for an extended duration. As with any investment, investors should meticulously evaluate their investment objectives, risk tolerance, and financial circumstances before making any investment decisions. One possible trading strategy involves going long on UGL in the event of a sudden gold price sell-off due to investors needing to raise liquidity to meet margin calls on other investments, such as equities during moments of panic. By discerning this pattern, investors may capitalize on market dislocations and acquire UGL at a discounted price.

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