Investors Flock To Inverse Gold ETFs

by on February 15, 2011 | ETFs Mentioned:

Precious metals have been on a tear for much of the last year, no doubt delivering huge profits to some of the hedge fund managers who began stocking up on bullion in early 2010. Physically-backed gold and silver ETFs took in close to $10 billion in inflows last year, as investors embraced the exchange-traded structure as the most efficient way to establish exposure to an asset class that has safe haven appeal and can perform relatively well in inflationary environments as well. With uncertainty over the global economic outlook swirling and concerns about an uptick in inflation lingering, gold surged to new record highs in 2010 after adding about 25%. But the yellow metal was overshadowed by silver, which gained close to 90% on the year. Forget the tiger, 2010 was the year of the precious metal.

But it seems that when the calendars changed, so too did the outlook for precious metals. Despite lingering uncertainty about the health of the global economy and concerns about eventual inflationary pressures, gold and silver gave back significant portions of their 2010 gains in the first few weeks of 2011. Last month was the worst January for precious metals in more than two decades, as gold prices tumbled more than 6% and silver declined by nearly 10%. The recent performance highlights some of the risks inherent in investing in precious metals–especially gold. Because there are no cash flows associated with the underlying assets, valuation can be a tricky task. Thanks to a lack of fundamentals, the prices for gold and silver can depend largely on market sentiment–which has been known to shift wildly over relatively short periods of time. That also means that detecting a bubble can be difficult. When the tech sector soared to new heights in the early 2000s, a look at the ridiculous pricing multiples was a pretty good indication that a bubble was forming. There are no such metrics available for gold and silver–which can make spotting an impending crash tricky.

Some investors remain bullish on a rebound–and precious metals have shown some resiliency in recent trading sessions. The five analysts ranked by Bloomberg as the most accurate over the last two years expect silver to rise about 24% this year and gold to add another 20%. But judging by where investors are putting their money, more and more are taking a bearish outlook on gold prices as well. A number of exchange-traded products designed to appreciate when gold prices dip have seen spikes in interest lately [for more ETF insights, sign up for our free ETF newsletter]:

PowerShares DB Gold Short (DGZ)

This exchange-traded note offers inverse exposure to the Deutsche Bank Liquid Commodity Index — Optimum Yield Gold, a benchmark that is comprised of gold futures contracts (currently, the index consists of gold futures with a maturity in August 2011). DGZ saw inflows of about $80 million in January–equivalent to more than 250% of assets at the beginning of the month. DGZ resets exposure to the underlying index on a monthly basis, distinguishing the short strategy employed from some exchange-traded funds that reset on a daily basis [read Five ETFs To Own During The Great Deflation].

PowerShares DB Gold Double Short (DZZ)

PowerShares and Deutsche Bank also offer a leveraged option for inverse gold exposure, as DZZ seeks to deliver returns equivalent to -200% of the same futures-based index (again, exposure resets on a monthly basis). DZZ surged in January as precious metals prices plummeted, finishing the first month of 2011 with a gain of close to 13%. As gold prices have rebounded in recent sessions DZZ has dipped slightly, but it still remains well in positive territory for the year. For investors who believe that gold prices will continue to slide, DZZ could be an interesting play [Reviewing Three Different Types Of Leveraged ETFs].

ProShares Gold UltraShort (GLL)

ProShares also offers a way for investors to achieve inverse leveraged exposure to gold, though GLL and DZZ are certainly not identical. This fund seeks to deliver results equal to -200% of the performance of gold bullion as measured by the U.S. dollar fixing price for delivery in London. GLL seeks to achieve this objective on a daily basis, meaning that returns over multiple periods depend on the volatility of gold prices as well as the change in price. Another important difference between the two: GLL is an ETF, whereas DZZ is an exchange-traded note that exposes investors to the credit risk of the issuer.

Direxion Daily Gold Miners Bearish (DUST)

In recent years many investors have embraced stocks of commodity intensive equities as a means of achieving exposure to natural resources. Because the profitability of these companies depends on the market price for their products (i.e., commodities), stock prices tend to move in unison with spot prices of the related natural resources. When gold prices are soaring, the outlook for the companies that extract and sell gold improves–and vice versa. The cleverly-named DUST offers -200% daily exposure to the NYSE Arca Gold Miners Index, the same index underlying the ultra-popular GDX.

Mining stocks often trade as a leveraged play on gold bullion, exhibiting a high correlation to spot prices but often considerably more volatility. Add in the 200% daily leverage and DUST is capable of delivering some pretty big price swings over a relatively short period of time. DUST gained more than 27% in January, and is an interesting option for investors looking to bet against gold prices and willing to take on a bit of risk [see Gold ETFs: Boom Or Bust?].

Disclosure: No positions at time of writing.