NUGT: As Recession Looms, Leveraged Gold Mining Bull ETF Makes Sense (NYSEARCA:NUGT)

Direxion Daily Gold Miners Index Bull 2x Shares (NYSEARCA:NUGT) is an exchange traded fund launched by Direxion Investments, and is managed by Rafferty Asset Management, LLC. It invests in derivatives of companies operating across the gold mining sector. The fund invests in futures and swaps of diversified market-cap stocks in the public equity markets around the globe. Almost 49 percent of its investments are in the equity markets of Canada, whereas the US and Australian equity markets hold 22 percent and 14 percent of its total investments.

The fund seeks to track 2x the daily performance of the NYSE Arca Gold Miners Index (GDMNTR), which is a list of publicly traded companies that operate globally in both developed and emerging markets, and are involved primarily in mining gold and silver. NUGT’s investment moves 2x upwards or downwards with respect to the GDMNTR. If the investments in GDMNTR goes up by 10 percent, the 2x investments will enhance NUGT’s value by 20 percent.

Direxion Daily Gold Miners Index Bull 2x Shares was formed on December 8, 2010, and is domiciled in the United States. Like most leveraged ETFs, NUGD also doesn’t pay any dividend. Due to the extreme level of volatility, these 2X funds are generally not suited to offer dividends. As the fund needs to invest twice the volume of its underlying index, the expense ratio is much higher than average ETFs. At present, NUGD has an expense ratio of 1.14. 2x investments also makes this 2x bull ETF much more volatile than its underlying index, and it may incur huge loss in case the index generates negative return.

GDMNTR’s major holdings is composed of stocks of renowned gold miners around the globe, such as 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), 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), AngloGold Ashanti Ltd. (OTCPK:AULDF), Yamana Gold Inc. (AUY) and Pan American Silver Corp. (PAAS). Together these 15 stocks constitute almost 75 percent of the entire index.

The index had lost 12 percent over the past one year. In 2022, the index generated a negative return of 5 percent. As NUGT invests in derivatives of all those gold miners that are also included in GDMNTR, and invests twice the volume of that index, this 2x leveraged ETF is expected to generate a much higher loss over the same time horizon. NUGT registered a price drop of almost 32 percent over the past one year and 16 percent during 2022.

I compared the performance of a few other leveraged bull ETFs from Direxion – Direxion Daily S&P Oil & Gas Exploration & Production Bull 2x Shares (GUSH), Direxion Daily Real Estate Bull 3x Shares (DRN), Direxion Daily S&P Biotech Bull 3x Shares (LABU), Direxion Daily Semiconductor Bull 3x Shares (SOXL), and Direxion Daily Small Cap Bull 3x Shares (TNA). Overall, I find that all Bull derivative ETFs in core sector (energies, commodities, real estate, etc.), such as GUSH and DRN have generated huge returns over the past year, whereas the bull ETFs from other sectors (healthcare, technology, etc.) like LABU, SOXL, and TNA have generated negative growth.

On the other hand, in the case of Bear 3x derivatives, the results are exactly opposite. During the past one year, Direxion Daily Gold Miners Index Bear 2x Shares (DUST), Direxion Daily Real Estate Bear 3x Shares (DRV) and Direxion Daily S&P Oil & Gas Exp. & Prod. Bear 2x Shares (DRIP) generated negative returns. Whereas, Bear leveraged ETFs from other sectors such as Direxion Daily S&P Biotech Bear 3x Shares (LABD), Direxion Daily Semiconductor Bear 3x Shares (SOXS) and Direxion Daily Small Cap Bear 3x Shares (TZA) made huge gains during the past one year.

All these negative and positive returns of leveraged ETFs are on expected lines. The current economic scenario that involves geopolitical turmoil, high inflation, series of interest rate hikes, rising unemployment, and looming recession, is detrimental for the non-commodities sectors such as healthcare, technology, financial, etc. As a result, unleveraged underlying ETFs performed poorly. Corresponding leveraged bull ETFs had multiple times negative returns, and due to their inverse nature, the leveraged bear ETFs will have positive growth.

On the other hand, stocks of core sectors tend to rise alongside inflation, and geo-political crises and are considered a safer bet during recession. As the unlevered underlying commodities indices post positive return under such scenario, the leveraged bull ETFs post enormous growth, and the leveraged bear ETFs tend to lose. Due to these simple reasons, Direxion Daily Gold Miners Index Bull 2x Shares should have generated high growth, as it deals on a precious and evergreen commodity – gold. Unfortunately, NUGT failed to capitalize on this trend.

The reason behind this is the poor performance of gold miners’ stocks, resulting in negative growth for almost all the gold miners’ ETFs. The year-till-date (YTD) growth of VanEck Gold Miners ETF (GDX) was -5 percent , VanEck Vectors Junior Gold Miners ETF (GDXJ) was -12.3 percent, iShares MSCI Global Gold Miners ETF (RING) was -10 percent, Sprott Gold Miners ETF (SGDM) was -2.3 percent, U.S. Global GO GOLD and Precious Metal Miners ETF (GOAU) was -10.5 percent, and Global X Gold Explorers ETF (GOEX) was -12.6 percent.

However, I am hopeful that the gold miners’ equities and ETFs will perform better this year. “A series of geo-political events, like unfavorable weather, pandemic-related disruptions, and Russian invasion of Ukraine have resulted in a shortage of supplies. The supply chain breakdown reduced supplies further and sent commodity prices higher. Although the impacts have not yet been reflected in the funds involving equity of gold mining companies, energy and commodity funds have generated high growth during 2022. Hopefully a positive impact will be felt in gold and natural resources based funds.”

As the general belief goes, “commodities tend to rise alongside inflation and serve as a hedge against declines in the other assets in a portfolio”, the gold price and correspondingly ETFs holding gold miners’ stocks should rise in the coming months. As the Federal Reserve Chairman, Jerome Powell bluntly pointed out that “interest rates would continue to rise until the central bank sees clear proof that inflation is slowing” and issues a warning that gradually increased rates could lead to a recession, I don’t see any reason why people will not invest more in gold in order to protect their capitals.

A negative YTD return of 16 percent may seem quite high. However, considering the loss gets multiplied in a 2x leveraged fund, this loss can be wiped out within a month or two once the underlying index delivers positive return. YTD price loss of most unlevered gold miners’ ETFs are not extremely high. The YTD price loss of GDMNTR is only 5 percent, which will not take much time to move into the positive zone, as the gold prices start moving upwards.

In fact, the price of gold moved downwards last year and also in the beginning of this year. And, only since February 2022, it witnessed a steep upward movement. Gold prices again dropped during May and is rising at a much slower pace at present. I am optimistic about this 2x leveraged bull ETF primarily because I am hopeful about the growth prospects of its underlying index. A sustained growth of gold price, which is most likely under the current economic scenario, thus makes me hopeful about Direxion Daily Gold Miners Index Bull 2x Shares.