Digging Deep With Leveraged Gold Miner ETFs As Higher Rates Loom

Gold and gold exchange traded funds got some much needed though likely temporary relief Monday as stocks tumbled. The scenario does not make much sense because if the myriad market wraps from the mainstream financial press are to be believed, the reason stocks fell is because investors are grappling with the reality that the Federal Reserve will raise interest rates next.

If higher rates come to pass, Treasury yields will begin reflecting that before the Fed makes it official. Along the way, the U.S. dollar will likely rise and commodities, including gold, are denominated in dollars. That means a stronger dollar, as has already been proven, is not a good thing for bullion-backed and gold mining ETFs.

The downtrodden Direxion Daily Gold Miners Bull 3X ETF (NYSE: NUGT) climbed about 7.2 percent on Monday on volume that was more than 80 percent above the daily average. However, the data point that more accurately reflects investors' expectations for what higher interest rates can do to gold miners ETFs is NUGT's one-month loss of nearly 42 percent, a slide that makes one of the worst-performing ETFs in Direxion's triple-leveraged lineup over that period.

Related Link: Rate Hike Odds Shine A Light On Leveraged Gold Miners ETFs

"Since gold is often viewed as a hedge against economic weakness, the strengthening U.S. economy has affected investment demand for gold, leading prices to fall. Goldminer stocks are an inherently leveraged play on gold prices. With expectations once again growing that the Fed will raise interest rates sooner rather than later, speculators are once again considering the leveraged trade on the miners," said Direxion in a new research note.

Here's the quagmire faced by traders: They inherently lean bullish when it comes to gold miners. That much is underscored by the fact that NUGT and its small-cap counterpart, the Direxion Daily Junior Gold Miners Index Bull 3x Shares (NYSE: JNUG), have added about $33 million in new assets this month as of Friday. Making matters potentially worse for traders that embrace an ETF like NUGT while eschewing the Direxion Daily Gold Miners Bear 3X Shares (NYSE: DUST) is that gold miners are tantalizingly cheap.

"The bulls may think that miners are poised to make a new run. In fact, according to Bloomberg, mining stocks are the cheapest relative to gold that they’ve been in 30 years. Some traders may take this as a sign to jump into miners because they’re oversold," adds Direxion.

Miners, including some found in the benchmark NUGT tracks, have been paring costs and selling assets as a means of bolstering cash positions should gold prices continue sliding.