Short-Sellers Guide To Gold Using ETFs

May 24, 2012

Several inverse funds can give investors exposure to falling gold prices, but timing is everything.


Many people are calling for the end of the secular gold bull market that started at the beginning of the last decade.

But even if you don’t think gold’s impressive run is over—up more than 600 percent since the bear market bottom in 2000—you may believe it’s due for a further correction.

Either way, if you don’t have the guts or the capacity to short GLD outright, you have options.

Luckily, there are three products on the market that give you inverse exposure to the yellow metal.

The PowerShares DB Gold Short ETN (NYSEArca: DGZ), the PowerShares DB Gold Double Short ETN (NYSEArca: DZZ) and the ProShares UltraShort Gold ETF (NYSEArca: GLL) all provide inverse exposure to GLD, albeit in different ways.

DGZ is the only one of the three that gives you unlevered inverse exposure to GLD.

DZZ and GLL, on the other hand, provide two times the inverse exposure to GLD. Further, DZZ and DGZ are ETNs, while GLL is an ETF.

That means DGZ and DZZ, which are backed by Deutsche Bank, are exposed to the credit risk of the issuer. In addition, DGZ and DZZ are reset on a monthly basis as opposed to GLL, which is reset on a daily basis.

In other words, GLL only promises its double leverage every day, whereas DGZ and DZZ promise to provide their inverse exposures on a monthly basis.

So which approach is better?

Well, as always, it depends —on the market, the trend and to some extent, the volatility of GLD.

Let’s take a look at how well these funds have delivered on their promises recently.

Here we have a chart of all three funds and GLD since Feb. 28, when gold began its most recent decline.

3-mo Performance of GLD & Inverse Funds

As you can see, GLD has lost more than 12 percent over the past three months, and the three inverse funds have actually provided better returns than you would expect.

In the case of DZZ, this outperformance has been the most pronounced. Why? First and foremost, the decline in gold has been orderly and efficient. It has fallen steadily and without significant volatility.

That type of trending market is the exact recipe for success in leveraged and inverse funds, even those that rebalance monthly.



Here are the same three funds and GLD since Aug. 28—a period that exhibited heightened volatility and a less distinct downtrend in GLD.

9-m Performance of GLD & Inverse Funds

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.

Long-Term Performance of GLD & Inverse Funds

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.

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