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Gold prices plunged over the past three months, making it almost impossible to find a money-making trade in the precious-metals sector during the second quarter. But by using exchange-traded products designed for short-term traders, those courageous enough to ride the wave downward in gold and silver prices were richly rewarded with huge gains. Let's take a closer look at these investments with an eye toward deciding if they make sense for those with a longer-term perspective.
The perfect time for precious-metals leverage
The best-performing exchange-traded products in the market were those that bet against gold and silver bullion and mining companies. In particular, VelocityShares 3x Inverse Silver ETN (NASDAQ: DSLV ) managed to rise 140% over the past three months, while the similar inverse gold ETN posted more modest gains of about 90%. Bets against mining stocks were equally lucrative, with the popular Direxion Daily Gold Miners Bear 3x (NYSEMKT: DUST ) coming close to matching the inverse silver ETN's performance at a nearly 140% rise.
What's somewhat surprising is the effectiveness with which these leveraged products have produced amazing returns. Over longer periods of time, leveraged exchange-traded products have typically been disasters for long-term investors, as volatility in both directions has steadily eroded the value of both bullish and bearish bets on the same markets.
But the current environment has been perfect for leveraged investments in precious metals, because the market has moved in one direction: down. That has knocked bullish investments for a largely fatal loop, with Direxion Daily Gold Miners Bull 3x (NYSE: NUGT ) having lost almost 80% of its value during the second quarter, necessitating a 1-for-5 reverse split just to hold its share price. The story is similar for VelocityShares 3x Long Silver (NASDAQ: USLV ) , with its decline of more than 70%.
What's next for these winning ETFs?
Investors have mixed thoughts about whether precious metals and mining stocks will continue their moves lower. In the past few days, gold-mining stocks have bounced off their recent lows even before bullion prices started to move higher, as bargain-hunting investors seemed to conclude that the beaten-down shares of miners and miner-tracking ETF Market Vectors Gold Miners (NYSEMKT: GDX ) represented a value proposition. Yet even though gold climbed yesterday to start off the third quarter, silver prices remained largely unchanged, pointing to a clear lack of resolve within the sector.
What investors shouldn't do is to conclude that leveraged ETFs are a viable long-term play based on one quarter's extraordinary performance. Anything short of a continued violent move downward in precious metals could lead to much weaker returns for leveraged products tied to their prospects. Too often, those who end up making the most from their leveraged plays end up overstaying their welcome -- and thereby give back much more of their returns than they expect.
Gold has outshone the stock market with strong returns since 2000, but more recently has given way to big declines. The Motley Fool's new free report "The Best Way to Play Gold Right Now" dissects the recent volatility and provides a guide for gold investing. Click here to read the full report today!