Leveraged And Inverse Gold ETNs Launch

February 28, 2008

Deutsche Bank leapfrogs ProShares in the race for leveraged commodity products.

Deutsche Bank has leapfrogged ProShares in the race to launch leveraged and inverse commodity products in the United States. The company announced today that it will launch three exchange-traded notes linked to the Deutsche Bank Liquid Commodity Index - Optimum Yield Gold. The new ETNs will trade on the NYSE Arca and are:

  • DB Gold Double Long ETN (NYSE Arca: DGP)
  • DB Gold Double Short ETN (NYSE Arca: DZZ)
  • DB Gold Short ETN (NYSE Arca: DGZ)

The notes are designed to provide +200%, -200% and -100% of the monthly return of the underlying index, respectively. Importantly, that index is tied to the value of an investment in gold futures, not gold bullion; the two prices do not always track perfectly. Moreover, like all commodity futures products, the notes incorporate the income futures investors would gain from investing their collateral cash in Treasuries. That will add approximately 5% of positive return to each index ... including the short and double short indexes.

Note that the Treasuries return will not be leveraged in the double up or double down funds; only the return of the futures contract will be leveraged.

The fact that the notes are tied to the monthly return of the index is noteworthy. That differs from the way the popular ProShares and Rydex leveraged ETFs work, as those funds are linked to the daily return of their benchmarks. That sounds like a nominal difference, but it is not: Because of the impact of compounding, doubling the monthly return as opposed to the daily return should allow these notes (in most circumstances) to stick closer to the long-term price trends of the underlying index.

An example will explain why. Suppose you have an index starts at 100, rises 20% on day one to 120 and then drops 10% on day two to 108 (10%*120=12). The fund that doubles the daily return would rise to 140 on day one and then drop to 112 on day 2 (10%*140=28). After two days, the fund that doubled the daily return would be up 12%, while the index is up 8%.

If instead you had a fund that doubled the two-day return, it would be up 16%. The longer the interval for each measurement, the closer (in most circumstances) you'll be to doubling the long-term return of an index.

That difference could be important. ProShares has filed papers with the Securities and Exchange Commission to launch leveraged, inverse and inverse-leveraged ETFs tied to various commodities and commodity indexes, including products linked directly to gold bullion; however, it has not received approval to launch these products yet in the U.S. Deutsche Bank appears to have been able to leapfrog ProShares by using the ETN structure, which has a more streamlined approval process than ETFs.

These are the first ETNs launched directly by Deutsche Bank, although it offers a family of commodity exchange-traded funds in partnership with PowerShares. In fact, the impetus for this launch is tied directly to the existing PowerShares funds. Last year, PowerShares and DB tried to convince shareholders in the PowerShares DB Gold ETF (DGL) to switch its mandate from tracking the basic index to doubling its return. That fund had gathered just $55 million in assets, overshadowed by the $19 billion streetTRACK Gold Fund (GLD); investors appear to like the simplicity of direct bullion exposure rather than the futures+interest exposure granted by DGL. PowerShares and DB thought that doubling the return might attract more investors and help differentiate the fund, but they were unable to gather the necessary votes for a proxy battle, and ultimately they gave up on the idea.

Clearly, Deutsche Bank was working on another approach.

The new notes charge 0.75% in expenses.

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