Double Gold ETF: Meaning, Risks, Example

What Is a Double Gold ETF?

A double gold exchange-traded fund (ETF) tracks the value of gold and responds to movements in the same manner as other similar double-leveraged ETFs. With a double gold ETF, the spot value of gold, or a basket of gold companies, acts as the underlying for the fund. The ETF attempts to deliver price movements equal to double the daily changes of the underlying gold value.

A double gold ETF strategy has the potential for significant profits. However, it is crucial to note that these funds have risks which may be substantial.

Understanding a Double Gold ETF

​​​​​​​Double gold ETFs are by no means a unique fund product. An ETF is a type of investment which owns the underlying assets, such as shares of stock, bonds, oil futures, and gold. The fund then divides ownership of those assets into shares. Through leverage, or the use of borrowed capital to fund the account, the ETF's goal is for future investment returns to double the commodity's daily return. This can be accomplished with futures and other short-term derivatives.

The first leveraged ETFs came to the market in 2006, after an almost three-year review by the Securities and Exchange Commission (SEC). As a fund sells new shares to an investor, they must report these sales. The Internal Revenue Service (IRS) views many exchange-traded funds as grantor trusts. All expenses and income become the responsibility of the shareholder investor. For funds held more than one year, the taxing of capital gains may be at a maximum of 31.8%.

Where's the Gold?

Double gold ETFs hold the physical hard metal bullion and try to mirror the market price of gold. The marketers of these funds say they are a safer and easier alternative for investors than if they had the gold coins or bars buried in their backyards. As the fund gains or loses investors, they will buy or sell the underlying bullion. 

A custodian holds the underlying asset for a double gold ETF. As an example, the housing of the bullion for the SPDR Gold Shares (GLD) is at the HSBC Bank plc in London, and the holdings are audited annually. Likewise, iShares Gold Trust (IAU) uses the London branch of J.P. Morgan Chase Bank N.A. as its custodian.

The Risks of Double Gold ETFs

The double gold leveraged ETF offers investors a prepackaged form of leverage without the margin requirements and complications that come with investing in swaps or derivatives. Other examples of leveraged ETFs include those in natural gas and crude oil. These ETFs can also aim to mimic an inverse movement relative to the underlying on a daily basis. Such ETFs are known as inverse ETFs. 

In theory, the value of the ETF should move with the market or an index, but this is not always the case. At times, the value of the ETF may change to a higher degree. They may even move in the opposite direction of the benchmark or market gold price. 

Leveraged ETFs aim to deliver advances equal to two, or more, times the changes of their underlying components each day. Leveraged ETFs mirror an index fund, but they use borrowed capital in addition to investor equity to provide a higher level of investment exposure. Typically, a 2X leveraged ETF will maintain a $2 exposure to the index for every $1 of investor capital.  

Maintaining a constant leverage ratio is complex. Fluctuations in the price of the underlying index continually change the value of the fund's assets. These changes require the fund to adjust its total amount of index exposure. 

However, in declining markets, rebalancing can be problematic. Reducing the index exposure allows the fund to survive a downturn and limits future losses, but it also locks in trading losses and leaves the fund with a smaller asset base. Having a reduced base will limit the fund's ability to return profits when the market moves higher.

Investors who purchase leveraged ETFs can reap substantial profits if the benchmark index or market moves in the desired direction in a given day or string of days. Leveraged ETFs offer the possibility of significant returns for traders who understand how they work and the risks that accompany them. 

Those who use these instruments will face the same disadvantage as investors who purchase securities on margin or use other forms of borrowing to finance their investments. Novice investors may want to consider the regulatory warnings and steer clear of these investment vehicles due to their ability to produce substantial losses over time if not monitored carefully.

Example of a Double Gold ETF

ProShares Ultra Gold ETF (UGL) is a 2X leveraged gold ETF. The fund uses futures contracts to try and double the daily return of the commodity.