Gold as an asset class had an outstanding performance from 2007 to its peak in 2011, jumping $640 to nearly $1800. This is a total return of almost 181% or 22% annually when the S&P 500 over the same period fell 15% (excluding dividends) and with much greater volatility. There is a strong historical correlation between gold and the US dollar.
Investors can purchase Gold through Gold ETFs such as GLD and IAU which move inline with the spot gold price. For those that are looking to use leverage in the investment portfolio, investors can use gold funds like 2x and 3x gold ETFs.
Risks of Using Leverage
There is considerable more risk using leveraged gold ETF. The gold price since the peak in 2011 declined 12% in 2012 and 26% in 2013. Since then gold price has been ranged bound.
The use of 2x or 3x gold leveraged ETF could have cause significant damage to investor capital base and return in those years. As always investors should tread carefully when using leverage. This risk can be managed through decreasing the allocation to the asset class when leveraged ETF is included in the portfolio.
2x and 3x Gold ETF
There are a number of ETFs investors can use to gain leveraged 2x and 3x exposure to the gold price. One important point must be highlighted is the relative small size of the asset under management of leveraged gold ETFs compared to the non-leverage gold ETFs. GLD and IAU gold ETFs has total of $33 billion and $7 billion worth of gold AUM. The leverage versions are much smaller and in some instances with limited intraday liquidity.
The research screens all the listed leveraged gold ETF and cut down most based on the criteria that the gold ETF must have sufficient daily traded volume for everyday investors and total AUM of more than $50million. With these criteria we have narrowed down to a list of 5 acceptable leveraged gold ETFs acceptable for investors.
The table below shows 4 2x gold ETF and a 3x gold ETF.
|PowerShares DB Gold Double Long ETN||DGP||2x||Futures|
|Deutsche Bank AG DB Gold Double Short ETN||DZZ||2x||Futures|
|Credit Suisse AG – VelocityShares 3x Long Gold ETN||UGLD||3x||Futures|
The bar chart below shows the relative size of AUM for the above leveraged gold ETF list. GLL which is the triple gold ETF is highlighted in red. While total AUM can be considered small. There is sufficient liquidity in the ETF due to arbitrage opportunities for market makers or investors to make the ETFs worthwhile.
3x Gold ETF Spotlight – New Kid on The Block
Credit Suisse AG – VelocityShares 3x is the newest leveraged gold ETF that gained traction with investors. Since its launch it has sufficient liquidity for those that are looking to 3 times the leveraged exposure to the gold spot price. The triple gold tracks the gold price through CME futures so the return over time is not exactly 3 times the return of the spot price. Similar to oil ETF 3x investors should be conscious of roll and yield risk involved in investing in futures.
Leveraged Gold ETF Holdings
Unlike GLD and IAU which were created under a standard trust structure where investors buying and selling the gold ETF means there is a corresponding change in the amount of physical gold held in the trust. None of the gold leveraged ETFs holds any physical gold. Each individual double or triple gold ETF mandate is to provide a return multiple of the day to day change in the gold price either using gold future contracts or commodity swaps.
As a result investors should be aware that tracking error could arise from these ETFs to the underlying spot price of gold on a day to day basis minor but the differences can add up overtime.
Inverse Gold ETF – 2x Short Gold Analysis (DZZ and GLL)
Price of DZZ and GLL increases when the spot price of gold decrease. Analysis below highlights how differences in the underlying assets of the ETF can affect overall ETF returns. You would expect both being short 2x gold ETF would have similar return profiles. However over the same timeframe DZZ outperformed GLL by 2.3%.
Going over the ETF prospectus which discloses the holdings of the double short gold ETF explains the large difference in the returns. DZZ gains exposure to gold price through gold futures contracts. The natural deviation of futures prices from spot due to cost of carry, implied storage cost and roll yield. As well as the shape of the futures curve either in backwardation or contagion creates a tracking error which overtime can cause server differences in absolute return between holding future and spot price. The ETF investing in gold futures also benefits from investing proceeds of the cash in treasuries which provides additional cushion to the net asset value.
GLL also does not hold physical gold but it does provide investors a direct exposure double short return of the spot price. The daily return of this double short gold ETF is 200% of the changes 4 pm spot gold fix from the prior day. Hence the day to day price of the GLL is the inverse of spot price just without the effect of compounding.
Over the 3 year period the difference in these 2 ETF is at 3.13% which shows that the spread can be relatively volatile and changes overtime. Investors need to decide if you are bearish on gold price. Then do you want to include the futures spread into your calculation or direct exposure through day to day multiple of spot changes. One fundamental investment principal still applies in this case which is greater risk means higher reward. The question is if the reward is worth the risk taken.