Leveraging the World's Most Precious Metal and its Miners

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The following post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga.

A Brief History of Gold

No other metal in all of human history has garnered more attention, lust and wonder than gold. Mankind’s preoccupation with this precious metal dates back to ancient times when it was first discovered around 4,000 B.C. in eastern Europe. The earliest use of gold as currency came in Egypt with the introduction of the shekel as a recognized standard of exchange for trade. Gold’s prominence in the financial realm didn’t stop there as time marched on civilization after civilization used gold as their main currency or as a store of wealth.

The historic strength and relevance of gold has reinforced investors in the modern age to see gold as an effective hedge against inflation.

Past performance is not indicative of future resuts.

Chart by World Bank Group

Inflation isn’t the only driver of gold. Interest rates, economic and political uncertainty, currency strength or weakness and gold production all play roles in driving the price of gold with economic uncertainty remaining the most influential of these factors. This tie to uncertainty and market fears makes the price of gold susceptible to price fluctuations based on news headlines especially ones that surprise the markets.

With so many factors influencing the price of gold, how should you think about trading it?

Many different investment vehicles are available to traders today from futures contracts for gold to exchange-traded funds (ETFs) that hold physical gold in vaults. There are even other ETFs that own shares of gold mining and production companies — offering some unique benefits not held by other gold trading options. 

Gold vs Gold Miners: The Difference is in the Leverage

Gold miners are companies that are involved in the discovery, mining and production of gold. Because their main product is gold, it makes sense that the value of mining companies is positively correlated to the price of gold. This positive correlation gives traders the opportunity to participate in the price movements of gold without having to buy physical gold or futures contracts directly.

While gold mining stocks track the price of gold fairly well, they tend to outperform the price of gold in bull and underperform in bear markets because of something called operating leverage. In simple terms, this refers to the shrinking or growing of a gold miners’ profit margins. Growing profit margins mean that a gold mining company is increasingly cash rich and therefore worth more as a company, at least on paper. Shrinking margins lead to a decrease in valuations due to decreased revenue and shrinking cash.

The following example will help you more easily understand this. If it costs a miner $650 to mine 1 ounce of gold and the current price of gold is $1,650 per oz, the profit margin would be $1,000. However, if the current price of gold increased by 10% from $1,650 per ounce (oz) to $1,815 per oz, and the cost to mine that ounce of gold remained at $650, the miner’s profit margin would have increased by 16.5% from $1,000 per oz to $1,165 per oz.

In a real-world scenario, the math would not be quite so simple. Costs per ounce would normally increase alongside the price of gold, sometimes outpacing gold price increases in bear markets which would eat into profit margins and often not keeping pace with increasing gold prices in bull markets, therefore, increasing profit margins.

The chart below shows the real-world scenario of operating leverage in action during the 2005-2010 gold bull market. 

There’s an ETF for That

This correlation and sometimes outperformance of gold mining stocks compared to the price of gold gives traders an opportunity to participate in the outsized gains experienced by gold mining stocks.

A great way to diversify this short-term trade is by using an ETF, like the ones mentioned, that holds a basket of many different gold mining stocks. This allows a trader to benefit from exposure to more than one gold mining stock at a time.

Direxion offers a few different types of gold miner ETFs that fall into 2 different categories: Gold Miners and Junior Gold Miners. The Daily Gold Miners Index Bull NUGT and DUST Bear 2X Shares both track the NYSE Arca Gold Miners Index. This index is made up of publicly traded companies that are involved in the mining and production of gold throughout the world.

The Daily Junior Gold Miners Index Bull JNUG and Bear JDST 2X Shares track the MVIS Global Junior Gold Miners Index. This index is made up of both foreign and domestic micro, small and mid-cap companies that are involved in the exploration of new mining deposits and or are currently mining gold. These companies are more speculative by nature. Therefore, their values tend not to be well correlated with the price of gold. Making them a less attractive trade for those looking to trade around the price of gold without conflating variables. 

We believe the Daily Gold Miners Bull and Bear 2x Shares, however, offer an excellent opportunity for traders looking for exposure to some of the world’s largest and most well-known gold mining companies. Names such as Barrick Gold, Newmont and Franco Nevada top the list of companies in these ETFs’ holdings. Not only can a trader make long plays using the Gold Miners Bull 2X Shares NUGT but a trader could also look to profit from a selloff in gold and gold miners using the Gold Miners Bear 2X Shares DUST.

Keep in mind that both of these ETFs are leveraged to seek 2 times the daily return of the underlying index but should not be expected to maintain this 2-time return over periods of time longer than 1 day because they are leveraged every day. Thus both NUGT and DUST are only appropriate for traders with short-time horizons, such as those who are looking to trade gold market swings driven by economic or political uncertainty.

Leveraged and inverse ETFs pursue daily leveraged investment objectives which means they are riskier than alternatives which do not use leverage. They seek daily goals and should not be expected to track the underlying index over periods longer than one day. They are not suitable for all investors and should be utilized only by investors who understand leverage risk and who actively manage their investments.

An investor should carefully consider a Fund’s investment objective, risks, charges, and expenses before investing. A Fund’s prospectus and summary prospectus contain this and other information about the Direxion Shares. To obtain a Fund’s prospectus and summary prospectus call 866-301-9214 or visit our website at direxion.com. A Fund’s prospectus and summary prospectus should be read carefully before investing.

CUSIP Identifiers have been provided by CUSIP Global Services, managed on behalf of the American Bankers Association by Standard and Poor’s Financial Services, LLC, and are not for use or dissemination in any manner that would serve as a substitute for a CUSIP service. The CUSIP Database, ©2011 American Bankers Association. “CUSIP” is a registered trademark of the American Bankers Association.

Shares of the Direxion Shares are bought and sold at market price (not NAV) and are not individually redeemed from a Fund. Market Price returns are based upon the midpoint of the bid/ask spread at 4:00 pm EST (when NAV is normally calculated) and do not represent the returns you would receive if you traded shares at other times. Brokerage commissions will reduce returns. Fund returns assume that dividends and capital gains distributions have been reinvested in the Fund at NAV. Some performance results reflect expense reimbursements or recoupments and fee waivers in effect during certain periods shown. Absent these reimbursements or recoupments and fee waivers, results would have been less favorable.

Direxion Shares Risks – An investment in each Fund involves risk, including the possible loss of principal. The Fund is non diversified and include risks associated with the Fund’s concentrating its investments in a particular industry, sector, or geography which can increase volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. Risks of t he Fund include Effects of Compounding and Market Volatility Risk, Leverage Risk, Market Risk, Natural Disaster/Epidemic and Market Disruption Risk, Counterparty Risk, Rebalancing Risk, Intra Day Investment Risk, Daily Index Correlation/Tracking Risk, Other Investment Companies (including ETFs) Risk, and risks specific to the Consumer Discretionary and Industrials Sectors and the Airline and Travel and Vacation Industries. The market prices of internet securities tend to exhibit a greater degree of market risk and sharp price fluctuations than other types of securities as these securities may fall in and out of favor with investors rapidly, which may cause sudden selling and dramatically lower market prices. Please see the summary and full prospectus for a more complete description of these and other risks of the Fund.

Distributor for Direxion Shares: Foreside Fund Services, LLC.

The preceding post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga. Although the piece is not and should not be construed as editorial content, the sponsored content team works to ensure that any and all information contained within is true and accurate to the best of their knowledge and research. This content is for informational purposes only and not intended to be investing advice.