Here are the same three funds and GLD since Aug. 28—a period that exhibited heightened volatility and a less distinct downtrend in GLD.
During this period, all three funds underperformed their promised leverage factors.
The combination of increased volatility and the absence of a clear trend worked against all three funds, even the monthly rebalanced versions.
Interestingly, the underperformance of the two funds employing monthly rebalances was less dramatic. It may be that the impact of compounding took less of a toll on these funds relative to GLL.
Now let’s take a look at a longer time frame, one in which GLD rose dramatically.
Based on GLD’s 104 percent return since December 2008, one might expect DGZ to be down 104 percent and DZZ and GLL to be down twice that.
The good news for investors in these funds is that all three of the funds lost much less than you’d first think they would. In fact, DZZ and GLL provided less than one times the negative inverse leverage, let alone double inverse exposure.
It would be easy to blame this on volatility, but GLD actually exhibited less volatility since December 2008 than it has since last August.
What is instead at work here is the impact of compounding. Although GLD has trended higher since December 2008, the extended period of study has created more opportunity for the power of compounding to create drift between what you’d guess the leverage factor should provide and what it actually delivers.
In this case it benefited investors, but that won’t always be true.
In sideways markets without a clear trend, these products will likely punish investors and, in the case of the daily rebalanced GLL, that punishment can be meted out quickly.
So that means investors must go beyond just deciding that they want to bet against gold.
They must determine if they think gold will fall in an orderly manner and over what time frame.
Further, they must decide if the decreased impact of compounding on DGZ and DZZ—thanks to their monthly rebalance schedule—is enough to override the embedded cost of default of owning an ETN.
Nobody ever said it was going to be easy.