Read this before buying

I will be travelling on Friday and therefore thought to post this blog as I have been asked about this by a few friends. The market is still holding up well this week and even trying to make a new high but failed on the closing basis. While it is just a matter of time to break out, I still think the downside risk is high for a swift flash “crash” in the weeks ahead. As such, I’d still advise not to be too complacent even if S&P breaks out to the new highs. A non-sustainable new high may just be a bull trap for the near term. I believe high volatility will continue to stay in the months ahead.

What I want to briefly talk about is the pitfalls of leveraged ETFs.  You may have heard some "experts" talking about buying JNUG (3 times leverage for junior gold mining stocks) or other leveraged ETFs for long term as a value play but this could be very dangerous if your timing is not perfect. I have heard a few sad stories, including some friends I know of. They bought JNUG last year when it was about $25 (split adjusted) when some "guru" recommended to buy and hold because it was "undervalued". Some folks did so even with fairly large amount but it has been a heartbreaking experience in the past year that JNUG has lost more than 2/3 of its value from $25 to now about $7. If one really understands the structure of such leveraged ETFs, it should be well understood that there is no intrinsic value for them and by design they are doomed to lose money over time. See what JNUG has performed since its birth about 4 years ago. Again based on its split-adjusted prices, it has come down from its beginning price about $800 to now less than $10! Where is the value? If you look at all the leveraged ETFs, most if not all behavior the same, as by design, they must lose money, if held for long term.

Actually I have talked about this two years ago about NUGT, a sister leveraged ETF for gold stocks (see here). Basically, leveraged ETFs are usually tracking futures of the underlying sector and as such they have to rollover month by month by selling lows and buying highs. So mathematically they have to lose money if you hold it for long term. The multiple coefficient (2 X or 3 X) is a bit misleading. You may think it should increase (for bull) or decrease (for bear) 2 or 3 times against the underlying sector and don’t do much if the sector stays sideways, right? Big mistake and that’s where many people get hurt badly. The leverage only works on the daily basis but long term, it will keep losing money in general due to the rollover (or the tracking error). The only time it may work well is your timing is perfect and the sector moves up strongly in the time period you are holding the ETF. That’s why leveraged ETFs are really only good for short term speculation for traders and is a worst idea to use it for long term investment. Even your direction is right but the trend is not so strong in your direction, you can still lose big money with them! 

So remember this: even if the sector is really cheap and great for long term investment like precious metals now, don’t be fooled by “experts” to buy leveraged ETFs for long term. There are simply no intrinsic values for them!