UGL: Leveraged Gold Could Be A Huge 2023 Winner (NYSEARCA:UGL)

I have been trying to explain the upside argument for gold as loudly as I can since the summer. For starters, the low “relative” valuation of gold vs. monetary expansion represented by the U.S. M2 money supply and Treasury debt outstanding (future required money printing) was discussed in November here. A second bullish argument is historically U.S. equities have been “more” overvalued vs. gold only 11% of the time over the last 100 years, measured by the Dow Industrial to Gold Ratio. Believe it or not, similar instances in 1929, the mid 1960s to early 1970s, and late 1990s to early 2000s, each turned out to be excellent times to buy-and-hold gold bullion.

What many newbie investors and Wall Street analysts do not completely understand is the hard money choices of gold (and silver) have turned into long-term bargains during late 2022. Expanding strength in gold overseas priced in currencies outside the U.S. dollar, and a technical base pattern in America point to the odds of a powerful upside resolution sooner or later.

Another way to play gold with leverage, absent the use of margin debt or being exposed to the operational swings/risks in gold mining stocks, is to hold the ProShares Ultra Gold ETF (NYSEARCA:UGL) product in your portfolio. UGL is not perfect, with a high 1% in annual management expense and decaying-value financial products owned (futures and swaps), but it has a better-than-you-would-think track record since inception in December 2008, especially if you did not purchase a stake near the 2011-12 peak in gold.

Gold vs. Dow Ratio

The inverse calculation of the Dow to Gold Ratio is worth reviewing below. Instead, we are looking at how gold has performed vs. stocks. I am projecting plenty of long-term gold potential beginning in 2023. Why? The gold price has already been performing somewhat better than the Dow Industrials since 2018. Drawing a green trendline from the 2011 gold ratio peak through the 2020 pandemic rush to monetary metals (hedging crazy money printing globally), we can see gold relative to stocks has been trying to break out all of 2022. In addition, a 2-year moving average (blue line) seems to work well for trend followers of this ratio. Both the trendline and moving average are sitting just below current quotes.

Given either equities decline swiftly (and gold holds its own) or gold begins to move higher faster, a double breakout could signal a multiyear span of gold outperformance vs. Wall Street has begun. This setup is strikingly similar to the 2000-01 span, marked with a blue arrow below.

On top of this compression launch potential, a closeup review of a second simple trendline (green) drawn from March 2020’s ratio high through June 2022’s peak suggests a minor 5% change in favor of gold would be super-bullish in coming months. Given positive action soon, the Gold/Dow Ratio may morph into its most bullish technical setup since 2019, if not 2001.

Rising Gold Demand

Other constructive developments for gold have popped up in the second half of 2022. Global central banks (the biggest holders of above-ground gold inventory) are reaching for a history-making buying spree this year. Q3 marked one of the highest net gold buys EVER by central banks over three months, and positions 2022 for the greatest net buying since 1967. 399 tonnes (almost 13 million troy ounces) were purchased between July and September alone, about the same as the entire 2021 year!

Implied Lease Rates Suggest Tight Supply

Yes, central bank buying is affecting the gold marketplace. Implied lease rates to borrow gold (or purchase it with a premium for future delivery) have skyrocketed since early June. Below are graphs of the situation. Notice the big jump in short-term 2-month rates. Just like the Treasury bond market, lease rates for gold can become inverted, which is an uber-bullish signal that current prices are not finding enough supply. In October, gold lease rates reached their highest level in over 14 years (2008). The last decade of fluctuations is pictured below. The structure and level of lease rates is nearly identical to late 2015 and early 2019. I have circled in green this inversion idea. Both past instances proved smart times to load up your portfolio with gold.

UGL vs. GLD Performance

Compared to the most popular gold bullion ETF by assets under management, SPDR Gold Shares (GLD), Ultra Gold has tracked as a decent choice to leverage up. The ETF uses daily rebalancing and compounding, which works against you in a bear market for precious metals, but can also pump returns over many months, sometimes well above the 2x daily return objective.

First, let’s look at performance for both ETFs over the last 52 weeks. With gold bullion quotes drifting lower much of the year and recovering with several big up days in November/December, the compounding feature has not helped overall returns. The 1-year UGL price return has been -7.7% vs. -0.8% for GLD.

The +38% return from GLD over the last 5 years has largely been mimicked by UGL. Again, if you can buy Ultra Gold before a sizable gold upmove, outsized gains can be achieved initially that provide a nice cushion to offset price slippage in future years. Sure, time decay on forward contracts has been a problem since 2018, but overall UGL returns have not been any worse than gold bullion.

August 2018 to August 2020 returns are pictured below. The steady daily gold gains over this span, and rebalancing design worked quite well to deliver a 2x investment return. UGL increased in value by +136% vs. the GLD advance of +66% over this specific span.

Nevertheless, here’s the rub. If you had purchased near the 2011 gold peak, UGL has been a rotten long-term investment. Below is a 10-year chart back to late 2012. Ultra Gold immediately doubled the -26% GLD loss into the end of 2013 with a -51% decline. The problem is this lower base during 2014 made it next to impossible for UGL to recover, despite the steady rebound in gold from 2018. Decade holders still have a -36% return loss on UGL capital, while GLD is now positive to the tune of +4%.

When the Ultra Gold ETF was issued in December 2008, gold prices were getting ready to rise markedly out of the Great Recession. Had you purchased on Day 1, UGL more than doubled GLD performance into September 2011. The GLD gain of +130% translated into +375% for UGL holders, approaching a TRIPLE, with the daily compounding of a strong underlying asset advance.

In the end, UGL has still been able to mirror the GLD gain over 14 years, despite high management fees and mild issues with premiums paid for forward contracts (contango). The keys are buying UGL near a gold price bottom and hoping lease rates/premiums for futures do not rise above low-single digits annually.

Below are 18-month graphs of daily price and volume changes for both UGL and GLD. You can easily see the slight underperformance of Ultra Gold during a flat to lower gold period, through today’s different interplay with each respective 200-day moving average.

Final Thoughts

My expectation is gold will follow silver’s strong rise since the summer into the seasonally-positive part of the calendar year between now and March (discussed in previous articles). I mentioned the upside potential of the ProShares Ultra Silver ETF (AGQ) in August here, which has doubled the +25% silver gain with a +53% jump over four short months (widely beating the -5% loss on the S&P 500 index).

In a similar vein, Ultra Gold could generate 2x the returns of a basic gold bullion increase in value soon. I am modeling US$2500+ gold in late 2023, with even higher quotes possible in 2024. Such would likely equate with a +70% to +80% UGL gain, depending on contract premiums and the pattern of daily rebalancing and compounding. Where else can you find similar upside potential in a recessionary economy over the next 12 months, uncorrelated (if not countercyclical) to bearish U.S. stock market changes?

Given a long-term uptrend in gold vs. equities (a logical conclusion of the Dow to Gold Ratio), now may be an excellent time to add the UGL product to your portfolio, effectively getting double the exposure to gold as your upfront investment capital into early 2023.

What are the risks? If you believe gold is overvalued (without any concrete evidence), and a large gold drop in U.S. dollars is approaching (highly unlikely outside of a deflationary depression), another year of flat to slightly lower bullion quotes could theoretically deliver -5% to -15% losses for ProShares Ultra Gold.

My question for those frightened by gold – why is investing in equities or cryptocurrencies not considered a high-risk endeavor vs. the successful record of gold (or silver) bullion investments over extended periods of time, priced in any past fiat (paper) currency backed by nothing but trust in politicians? While cryptocurrencies are completely untested standing less than 15 years from invention and stock markets have only existed for a few hundred years, precious metals have a history of investment gains (holding wealth at a minimum) over thousands of years.

A combination of record U.S. debts (in aggregate vs. GDP output) will likely not mix well with 2022’s record (relative) increase in interest rates. You have to remember we are trying to exit the experimental QE money printing scheme started by former Federal Reserve Chairman Ben Bernanke in late 2008. There are no guarantees the economy will function normally next year, which could mean another round of QE and Treasury deficit borrowing may soon be necessary to combat a developing recession.

Plus, black swan events for the financial system from new or expanded wars, surprise spikes in oil/gas, ongoing COVID supply-chain issues (especially out of China this winter), and more could cause a rush of investor and institutional buying of gold and precious metals to hedge reality.

Why not own gold as a major position in portfolio design is my question? And, if you want to hedge a world experiencing massive political and international trade changes, why not find ways to leverage gold upside at minimal risk?

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.

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