It's a standard part of the investment world that we should use the correct instrument for the strategy we're trying to employ. Using the wrong instrument can lock us into losses that are simple unnecessary. This is true of the choice between VanEck Gold Miners ETF (NYSEARCA: GDX) and MicroSectors Gold Miners 3X Leveraged ETN (NYSEARCA: GDXU).
GDXU is, in part, simply a leveraged holding in GDX, which doesn't, in fact, sound all that interesting. However, GDX is only large scale and mature gold miners. This means that it is, near entirely, a speculation or play on the gold price. Gold mining costs don't change with the gold price. Nor does the amount of gold in a mine change all that much - we've usually a decade's visibility on future production at a large mine. The thing that changes is the gold price, that then feeds directly through to gross and then net margins for a miner. Gold stocks are therefore already leverage to the gold price.
GDXU also includes another ETF, one holding smaller and junior miners. There geology - and even exploration - have an influence. So one is not quite the leveraged equivalent of the other but they're close.
GDX share price from NASDAQ
GDXU stock price from NASDAQ
So, if we want to ramp up the leverage why not go with the leveraged ETN instead of the ETF? We get both the leverage of the gold stocks to the gold price and also the extra 3x leverage of the ETN.
Well, depending upon what we're trying to do, why not? But it does depend upon what we're trying to do. If we're thinking about long holdings then we simply don't want to go that ETN, leveraged, route. For: “GDXU is a note that provides 3x daily leveraged exposure. As such, it is not a buy-and-hold product, and is best designed for short-term tactical trading purposes only. Returns can vary significantly from 3x exposure to its underlying index if held for longer than a day.”
Or, if we look at 12 month returns, GDX (as of today) is 1.18% down, GDXU is 46.43% down. That extra - approximately - 40% decline is the price paid over time for access to that leverage. It's far cheaper therefore to go with the ETF and gain the leverage elsewhere - from a broker, through a contract for difference or even just straight borrowing.
Now, whether we should be using leverage on a speculative position is another matter entirely. But this is good example of how we've got to use the correct instrument for our purpose. Leveraged ETNs simply aren't for making long terms positions or bets. So, don't use them that way.
