Direxion fund ETF discrepancies and their effects on gold stocks
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
Since the collective government response to prospective dangers of the COVID-19 coronavirus has been to shut down the global economy, the volatility in most everything traded has been immense. The trading atmosphere during the resulting financial crisis has, at times, been especially cruel to investors who have placed short-term bets on certain Direxion Fund 3x ETF’s, and many other 3x ETFs, to take advantage of this extreme volatility.
These higher-risk leveraged vehicles are primarily used by day-traders, whereas investors are warned of the time erosion factor in the ETF’s prospectus. But over the past month, many of the 3x leveraged funds have malfunctioned and diverged away from their actual NAV while not providing the leverage advertised to those holding them at the time. For example, both the bullish JNUG and bearish JDST were hit with huge losses last month to the tune of an average drop of 85.5%, although the ETF they track, GDXJ, was down just 22%.
Furthermore, these discrepancies have also affected the trading of gold stocks not included in the Van Eck miner funds, as investors in higher risk juniors make buy/sell decisions based on the performance of both GDX & GDXJ. Once critical technical support/resistance levels in these funds are broken, investors use these signals as correlations to buy/sell juniors outside of the Van Eck ETF’s.
As a result of this big increase in volatility since mid-March, fund managers who run mining ETF’s have been overwhelmed by the huge volume coming into this tiny sector. One reason for excess slippage during normal trading volume is the fact that 30% of GDX holdings do not trade synchronously with U.S. markets.
About 14% of the fund is Australian, with another 15% or so in European time zones, which means the index GDX tracks includes some stale prices. The firms traded outside of North America will also show up in the index print every evening while NAV uses fair value pricing on those stale issues, making it appear like the ETF is not tracking its index (when in fact it usually is).
But if you look at the trading history during days of extreme volatility in the Direxion Funds NUGT, JNUG, JDST, & DUST since mid-March, there have been glaring discrepancies in relation to the underlying ETF that each are trading with. While some of this can be explained by the pricing differences mentioned, the recent dislocations are much more dramatic than one placing a trade expects.
Moreover, the high volume in these 3x Direxion miner ETF’s have been affecting the performance of the corresponding Van Eck funds GDX & GDXJ. On March 18th, NUGT closed at a 52.2% premium to its NAV (price was $7.48, NAV was $4.78). GDX closed at $19.68 on March 18th on heavy volume of 198 million shares. This was a huge drop of over 23% from the March 17th close of $25.50.
Also, on March 18th, JNUG closed at a 44.4% premium to its NAV (price was $5.08, NAV was $3.52). GDXJ closed at $24.85 on March 18th on heavy volume of 53.8 million shares. This was an even larger drop on this day than GDX of over 32% from the March 17th close of $32.99. There have been many other lower percentage price discrepancies that have occurred frequently since mid-March, as the daily volatility in these funds was up to 5x higher than normal during a few sessions last month.
It was probably not a coincidence that on March 20th ,Direxion made the decision to reduce the exposure on both NUGT and JNUG from 3x to 2x and issued a press release to shareholders stating: "In consideration of the best interests of shareholders, the Board of Trustees of the Direxion Shares ETF Trust has approved changes to the names, investment objectives, and investment strategies of 10 leveraged ETFs, effective May 19th."
Then, on the afternoon of March 27th, Direxion decided to change the effective date to March 31st at 4pm EDT, providing shareholders only a two-business day notice before reducing exposure from 3x to 2x. With the mining sector trading so thinly versus other sectors, this abrupt decision had a profound impact on the volatility of mining shares into the quarter-end.
John Feneck, former VP of Sales at Sprott Asset Management, informed me that shareholders were not provided anything in writing about the March 27th decision to accelerate the change from 3x to 2x until the day changes were enforced on March 31st. As a comparison, Van Eck provided a 60-day notice before making a GDXJ prospectus change in the spring of 2017, which gave shareholders ample time to make decisions.
Although Direxion’s snap-decision to lower the 3x leverage to 2x in these ETF’s should alleviate some of the slippage, it remains to be seen if the firm can get these high-risk funds back to the advertised leverage performance on a consistent basis if/when extreme volatility like we saw last month returns to the gold space.
As the precious metals complex continues to go through the painful transition of being a defensive deflationary hedge to an inflation play, these high-risk 2x leveraged funds should be avoided by resource stock speculators until we see consistent lower trading volatility return to the sector.
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