One of the questions many investors are asking right now is if they should be selling short gold and gold mining stocks or buying a short gold ETF.
A strengthening U.S. dollar index—one of the main catalysts behind gold’s weak performance lately—is the reason why some are contemplating short sales. Gold is priced in dollars, and currency strength accordingly tends to result in bullion price weakness. With the dollar now benefiting from safe-haven demand from investors worried over the Delta strain of the coronavirus (and other factors), it’s only natural that participants with a higher risk tolerance are seeking to profit from the dollar’s strength by shorting gold.
But is shorting gold and the companies that produce it a good idea? Selling short has never been easier than today thanks to the advent of inverse ETFs. (Inverse ETFs are structured to move in the opposite direction of the underlying asset, in this case gold stocks). One of the most popular inverse ETFs for traders who want to a short gold ETF is the Direxion Daily Gold Miners Index Bear 2X Shares (DUST).
DUST provides two times (2X) reverse exposure to a market-cap-weighted index of global gold and silver mining companies, namely the NYSE Arca Gold Miners Index. Although it isn’t tied directly to it, the fund moves in roughly the opposite direction of the more well-known PHLX Gold/Silver Index (XAU). (The NYSE Arca Gold Miners Index has a slightly more international scope than the XAU.)
If you’re a gold trader who isn’t averse to selling short, rather than assuming the added risk of shorting individual gold mining stocks, a short gold ETF like DUST is an ideal alternative. Think of it as a “one-size-fits-all” vehicle for shorting the sector.
That said, I don’t typically recommend selling short gold or gold stocks in my investment advisory, the SX Gold & Metals Advisor. Unless you’re extremely nimble and not averse to getting in and out of a trading position quickly, short selling is usually not a good idea. Since it involves leverage, inverse ETFs tend to be more volatile than the more typical (and positively correlated) market-tracking ETFs.
Indeed, declines in a bull market tend to be fast, short-lived affairs. So, if you try to hold onto a trading position a short gold ETF like DUST after it shows a profit, it’s very likely you will surrender all your profits fairly quickly when short covering begins and the buyers return to take advantage of lower prices. (Incidentally, that’s never been truer than in today’s Reddit-fueled short squeeze environment.)
Another disadvantage of selling short gold and gold stocks is that by doing so, you’re adding an extra variable to your trading or investing system. When it comes to the financial markets, I firmly believe that the fewer variables you have in your system, the more likely it will consistently make you a profit. Trying to predict the market’s next major move is hard enough without increasing your chances of being wrong on both ends (long and short).
Moreover, over the long term, the prices of gold and gold stocks—much like the U.S. equity market—are more apt to trend higher than lower. Focusing on only the long (bullish) side of the market during rallies, then moving to cash when the dollar strengthens and gold weakens, typically yields better results than trying to buy and sell short, which normally requires excellent timing beyond the expertise of most investors. (The old adage comes to mind, “He who tries to ride two horses at once falls between them.”)
There are, of course, exceptions to almost every rule. And the exception for selling short gold and gold stocks involves periods of prolonged strength in the currency market. Specifically, if the U.S. dollar index establishes a consistently rising trend over a few months, and gold has clearly entered into a bear market (based on deteriorating fundamentals), it would probably make sense to have some exposure to a short gold ETF like DUST—but only if you were willing to tolerate the extra volatility risk.
It’s true that gold and many actively traded mining stocks have shown a measure of weakness recently, while the dollar has shown strength. However, there aren’t sufficient reasons for assuming that gold has entered into a secular bear market. Therefore, it’s my view that conservative investors should avoid gold stock short sales for now.
For more of Clif Droke’s insight into gold and precious metals investing, subscribe to SX Gold & Metals Advisor today!