During the financial crisis, leveraged ETFs became very popular ways to make the most of already huge volatility in the stock market. But even as stocks have started to trade in a more confined range following two strong years of gains, traders looking for the next thrill ride have taken their game to the next high-volatility arenas: precious metals and oil.
Too much of a good thing?
You'd think after last week that the last place anyone would need any more volatility would be in the precious-metals markets. In particular, with silver dropping more than 25% in a single week, only to bounce strongly Monday and then fall just as sharply yesterday, you could hardly ask for a more turbulent market. Similarly, as gasoline prices have pushed above the $4 mark in many parts of the U.S., concerns about falling demand from high prices finally persuaded the oil market to halt its bull run at least temporarily, with a swift drop from more than $115 per barrel to below the key $100 price level.
But let's face it: Anywhere someone's making 25% in a single week, you can find someone else who won't be satisfied with anything less than 50%. Those are the investors who have gravitated to leveraged ETFs covering the precious-metals and oil sectors.
Getting rich
Until last week, the success story of the year was the ProShares Ultra Silver ETF (NYSE: AGQ). Thanks to an almost uninterrupted run upward, the ETF, which offers double-leveraged daily returns corresponding to changes in silver prices, jumped an astounding tenfold in the two years that ended April 29. And even though gold has lagged behind silver, investors in ProShares Ultra Gold (NYSE: UGL) were rewarded with a near triple during the same time frame.
But things have turned on a dime, and suddenly the bearish versions of these funds and others have come into vogue. ProShares UltraShort Silver (NYSE: ZSL) jumped more than 75% in just four days last week as silver plummeted, causing its bullish counterpart to lose fully half of its value. Perhaps most importantly for the ETF companies, volume has soared to huge multiples of normal levels, increasing recognition and highlighting the lottery-like gains that they can offer during turbulent times.
Investors have been used to using ETFs like Direxion 3x Daily Energy Bull (NYSE: ERX) and Direxion 3x Daily Energy Bear (NYSE: ERY), which target indexes of energy stocks, as indirect proxies for oil price movements. But more recently, ProShares Ultra DJ-UBS Crude Oil (NYSE: UCO) and ProShares UltraShort DJ-UBS Crude Oil (NYSE: SCO) have gained attention because the futures contracts they hold give investors a direct connection to changing oil prices rather than relying on correlations between oil prices and energy stocks
Keep calm
Just like a Vegas gambler who cringes when he hears a bunch of folks at the next table screaming for joy over their big winnings, it's hard not to want to get in on the literal gold rush that's going on in oil and precious metals right now. But remember a few things:
- For every shareholder who's making money on a trade, someone else was on the other side and either lost big or missed out on a huge gain.
- As long as markets move in one direction, leveraged ETFs do well. But once big one-way moves give way to the inevitable up-and-down bounces that markets usually show, the daily return structure of leveraged ETFs hurts investors even if they end up correct about the eventual direction of the target market.
When speculative fervor takes over a market, it's tempting to join in the fun in the hopes of cashing in. But more often than not, you'll do better watching from the sidelines than you will if you try picking short-term directions for volatile markets like oil and precious metals.
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