Gold is smokin’. But there’s one way you don’t want to play it.

Leveraged funds that own gold are up by triple digits this year. But they can fall just as fast. With gold up roughly 30% this year and gold mining stocks up even more, gold-focused funds that borrow money to amp up returns, are on a tear.

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Gold Miners Index

The $701 million Direxion Daily Gold Miners Index Bull 2x Shares ETF is up 188.5%. And the $542 million ProShares Ultra Gold 2x Exchange traded fund (ETF), which seeks to provide twice the daily performance of the Comex gold futures contracts, is up 55%.

What’s not to like? Well, if you’re a buy-and-hold investor, a lot is wrong. Leveraged bets can produce sharp gains, but they can also make you very poor, very quickly.

How poor? Look at what happened to the leveraged funds this year that bet against gold miner prices. The $125 million Direxion Daily Gold Miners Index Bear 2X ETF, an inverse fund that seeks to profit when prices fall, is down 74.5% year to date.

Leveraged funds are designed for traders, and others making short-term bets. They aren’t for someone who is buying gold for the classic reasons investors own the yellow metal, which is as a portfolio diversifier, an inflation hedge, an insurance policy or an alternative currency.

How leveraged funds work

Most leveraged funds are structured as daily average products. If the underlying investment moves by a certain percentage on a particular day, then the leveraged ETF is designed to move by a multiple of that, says Aniket Ullal, head of ETF research and analytics at CFRA Research.

That said, a fund that has two times leverage won’t move exactly twice the amount of its underlying asset for two reasons, Ullal says. The first is the financing cost. Many of these funds use derivative contracts known as swap agreements for the leverage, which has a cost. The second is the volatility of the underlying asset. Volatility tends to distort returns over time when it comes to leveraged funds.

That can be seen by comparing gold’s year to date return versus the ProShares fund. The ProShares fund is up 55%; however, gold is up 29%, so the fund’s return is about three percentage points short of being up twice gold’s return.

Gold Miners fund

Another real-life example of the volatility drag happened in April when markets were whipsawed following the White House’s tariff announcements. The VanEck Gold Miners fund was up 6.6% for April, but the Direxion leveraged fund, which uses the VanEck fund as its underlying index, rose 9.9%. A true doubling would have put the Direxion fund’s April return at 13.2%.

It gets worse. There are times when the underlying asset can have a positive return and leveraged funds can lose money, such as during 2020’s extreme market moves. Morningstar data show the VanEck fund rose 23.7% that year, but the Direxion leveraged fund lost 60.2%.

The 2020 example shows how time magnifies these distortions, says Curtis Congdon, president of XML Financial Group. That why he says that leveraged gold fund should only be used for short-term trades.

Gold ETFs

“I think the people who look at levered gold ETFs are misplacing the effectiveness of gold in a portfolio, and perhaps instead, should be looking at technology stocks rather than leverage gold ETFs,” he says.

Ed Egilinsky, managing director at Direxion, says this year’s stellar return for leveraged gold-miner funds is unusual because it’s rare that a market goes straight up with little volatility, as has been the case for gold miners. He says that investors shouldn’t count on leveraged gold funds going up smoothly.

“To me, that’s fool’s gold, because most markets don’t go up straight up without some sort of volatility to the downside,” he says, adding, “I wouldn’t recommend people hold these indefinitely.”

Gold is in a strong uptrend now, buoyed by central bank buying over the past few years. But the metal has had years of little price movement in the past. After its last run in the 1980s, gold saw range-bound trading until about 2005.

MicroSectors Gold Miners

If you buy a leveraged gold fund, you need to know exactly what you are owning. Not only does leverage vary, but the products are also different. Most leveraged gold investment products are ETFs, at least one, the $877 million MicroSectors Gold Miners 3X Leveraged ETN, is an exchange-traded note.

An ETN is an unsecured debt instrument issued by a financial institution, but trades like an ETF. ETNs introduces counterparty risk if the issuer can’t pay, leaving investors on the hook. ETN defaults are rare, Ullal says, but remain a risk.

Overall, Ullal says, these are best left to buyers who understand these complex products.

“If they understand the concept of volatility decay, and also the fact that these things can be so volatile, I think that’s the key. My experience has been that not a lot of investors understand all of that, even financial advisors,” he says.

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