Gold got hammered last month, falling to $1,164.25 on Oct. 31 from $1,216.50 the last trading day of September – a 4% decline. And that was the basis for the Direxion Daily Junior Gold Miners Index Bear 3X fund’s 96% gain in October. One way to leverage gold – that is, boost gains on the way up and losses on the way down – is to buy shares of gold-mining stocks. Consider a company that could get gold out of the ground for $1,000 an ounce. At $1,200 an ounce, the company makes a $200 profit.
Now suppose gold rises to $1,300 an ounce – an 8.3% gain. For the mining company, however, earnings have risen to $300 from $200, which is a 50% increase. In theory, the stock’s value should rise far more than gold. Going in the other direction, the results aren’t as happy. If gold fell to $1,200 from $1,300, a bullion investor would be down 7.7%, but the mining company would see earnings tumble 33%.
Smaller mining companies tend to be more volatile than larger ones, so if you want to be really risky, you can invest in the so-called junior mining companies. These may have to borrow extensively to get the gold out of the ground. You’d expect junior gold stocks to fall more than larger gold stocks when the price of gold falls, and you’d be right. The Market Vectors Junior Gold Miners ETF fell 25.8% in October.
So how do you turn that frown upside down and turn it to insanely giddy laughter? Create a fund that bets that junior gold miners will fall – taking a short position, in Wall Street parlance. Then use futures and options to boost returns (and losses) even further, so much so that for every 1% the junior miners index falls, the fund rises 3%.