A healthy market often makes a statement. Last week while other commodity prices and markets across all asset classes were moving lower, gold displayed incredible strength. During the height of the global financial crisis, the price of gold dropped like a stone. The price had just made a new high and moved above the $1000 per ounce level for the first time in history in March 2008. Only seven months later, the price dropped to a low of $681. Since 2010, the price of the yellow metal never returned to below the $1000 level. The closest it came was in late 2015 when it hit a bottom of $1046.20.
Last June, gold broke out of a $331.30 trading range that contained the price since 2014. The price rose to a high of $1559.80 in September 2019, and in January 2020, it made a new and higher high of $1613.30. Gold was trading at around the $1580 level on the active month April COMEX futures contract on February 3. Gold mining stocks tend to outperform the price action in the gold market on a percentage basis when the price is appreciating. Junior gold mining stocks often do even better. The Direxion Daily Junior Gold Miners Index Bull 3X Shares (NYSEARCA:JNUG) is a leveraged product with exposure to a diversified portfolio of junior gold mining companies.
Gold continues to shine, despite risk-off conditions
January turned out to be a rough month for many of the leading commodities. Both crude oil and copper put in bearish reversals on their respective monthly charts. The price of crude oil fell 15.65% during the first month of 2020, and copper shed 10.24% of its value. Gold tuned out to be a bastion of safety as the price moved from $1520 at the end of 2019 to $1588.50 on the nearby futures contract on January 31, a gain of 4.5%.
As the long-term quarterly chart highlights, gold posted consecutive gains over the past five quarters. A close above $1520 at the end of March 2020 would mark the sixth quarter of gains in a rose. Gold has a history of consecutive quarterly increases. From 2008 through 2011, the price moved higher over twelve straight quarters. Price momentum and relative strength indicators on the long-term chart both signal a continuation of the bullish trend but are heading towards overbought conditions. However, the metrics remained in overbought territory from 2004 through 2011. Open interest, the total number of open long and short positions in a futures market, has moved higher with the price of gold. The metric reached a record high of 798,822 contracts on January 23 but pulled back to under the 680,000-level late last week. Profit-taking because of fears over risk-off conditions in markets across all asset classes likely led some market participants to close out risk positions in the gold futures market. However, gold’s shine has only increased as Coronavirus caused volatility in most other markets.
Gold mining shares are a leveraged play on the yellow metal
The companies that extract gold from the crust of the earth tend to outperform the gold futures market on a percentage basis as the price of the yellow metal rises. A successful gold producing company sells its output at a higher price than it costs to produce. In a rising market, the bonus of higher prices creates a leveraged return for gold miners. The price of gold rallied from $1266 per ounce last April to a high of $1559.80 in June 2019, a rise of 23.2%.
The chart shows that during the period when COMEX gold futures moved 23.2% higher, GDX rallied from $20.14 to $30.96 per share or 53.7%. The gold miners provided a leveraged return compared to the price of gold and acted as a twice geared product. Gold mining stocks tend to do best during the period when gold is rallying to new highs.
Junior gold miners tend to display more volatility than the leading mining companies
Junior gold mining companies provide an even higher level of leverage during rallies. The smaller companies are often involved in exploration projects with greater risk. However, higher risk tends to offer far more attractive rewards during bull market periods.
The VanEck Vectors Junior Gold Miners ETF product (GDXJ) holds a portfolio of the more volatile gold mining companies. The most recent top holdings of GDXJ include:
Source: Yahoo Finance
During the period when gold moved 23.2% higher, and GDX was up by 53.7%, GDXJ did slightly better than GDX.
As the chart shows, when gold broke out to the upside following the April 2019 low at $1266, GDXJ moved from $27.80 to $43.10 per share or 55%.
Since junior mining shares are even more leveraged to the price of gold, another leg to the upside could create significant percentage gains that exceed both gold futures and the GDX.
JNUG turbocharges the volatile junior mining shares
GDXJ may be the most leveraged of the gold mining ETF products that do not contain additional gearing when it comes to the mining shares. For those looking to magnify results even further, the Direxion Daily Junior Gold Miners Index Bull 3X Shares product turbocharges the price action in junior gold mining shares held in the GDXJ product. The fund summary for JNUG states:
The investment seeks daily investment results, before fees and expenses, of 300% of the daily performance of the MVIS Global Junior Gold Miners Index. The fund invests at least 80% of its net assets (plus borrowing for investment purposes) in financial instruments, such as swap agreements, and securities of the index, ETFs that track the index and other financial instruments that provide daily leveraged exposure to the index or ETFs that track the index. The index includes companies from markets that are freely investable to foreign investors, including ’emerging markets,’ as that term is defined by the index provider. It is non-diversified.
Source: Yahoo Finance
The most recent top holdings of JNUG include:
Source: Yahoo Finance
JNUG has net assets of $1.14 billion and trades an average of over 2.79 million shares each day, making it a highly liquid product. JNUG charges an expense ratio of 1.17%. During the period when gold rallied 23.2%, the GDX put in a 53.7% gain and GDXJ appreciated by 55%, JNUG’s performance left the other gold and gold-related products in the dust.
The chart shows that JNUG moved from $31.55 to $104 per share or 3.3 times higher.
Timing is everything
Triple leveraged products like JNUG offer incredible returns, but those rewards come with a far higher level of risk. The price of leverage is time decay. If the price of gold and junior gold mining shares remains stable or moves lower, the price of the JNUG product will evaporate. However, when gold goes on a bullish tear, JNUG acts like the yellow metal on steroids. Therefore, timing is everything for JNUG and other triple-leveraged products.
Gold’s price action in the face of risk-off conditions in most other markets is a sign of underlying strength. After trading to a new high of $1613.30 on January 8, the price of April futures was threatening to move above the $1600 per ounce level at the end of last week. If gold is going to take off on the upside like a rocket ship and challenge the 2011 high at $1920.70, the JNUG product has the potential to explode to the upside. JNUG contains supercharged rock fuel. Timing and discipline are critical when considering products like JNUG. A plan that includes tight stops, re-entry on price dips, and accepting a series of small losses in the quest for a more significant gain is the optimal approach for triple leverage. I remain bullish on the prospects for gold. The yellow metal is telling us that higher highs are on the horizon during a period when most other asset prices are suffering significant corrections.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.
The author is long gold