WHAT IS 'Reverse Gold ETF'

A reverse gold ETF is an exchange traded fund, or ETF, designed to trade opposite gold bullion. Reverse gold ETFs, or inverse gold ETFs, are generally used by investors to hedge against a downward move in gold prices, or by speculators to execute a bearish trade in gold.

BREAKING DOWN 'Reverse Gold ETF'

Reverse gold ETFs enable retail investors to take a bearish view on gold with limited amount of capital. For example, an investor who wishes to hedge $5,000 of gold exposure can buy an inverse gold ETF. Assume the ETF units are trading at $10, so the investor buys 500 ETF units. If the price of gold falls by 4 percent the next day, the ETF units should trade 4 percent higher, or around $10.40. The increase in the value of the inverse ETF units offsets the decline in the investor's gold stocks portfolio. Reverse gold ETFs typically deliver the inverse of the daily return of physical gold; leveraged inverse gold ETFs deliver a multiple of 2x or 3x the daily inverse return of gold. Because their performance depends on the daily return of gold, inverse gold ETFs, like all such ETFs, may underperform during periods of heightened volatility in gold prices.

Reverse gold ETFs and leveraged ETFs

The first leveraged ETFs came to the market in 2006, after an almost three-year review by the Securities and Exchange Commission. 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 leveraged ETF will maintain a $2 exposure to the index for every $1 of investor capital.

The fund's goal is for future appreciation of the investments made with the borrowed capital to exceed the cost of the capital itself. Leveraged ETFs offer investors prepackaged leverage that does not necessitate the requirements and complications that come with investing in swaps or derivatives. Investors who purchase leveraged ETFs may reap exponentially larger profits from underlying price movements if the benchmark index or market moves in the desired direction. But those who use these instruments will face the same disadvantage as investors who purchase securities on margin or use any other form of borrowing to finance their investments. Leveraged ETFs offer potential significant returns for investors who understand this market and the accompanying risks. More risk-averse investors may prefer to avoid leveraged ETFS because although they can be valuable additions to a portfolio, they may produce substantial losses over time if not monitored closely.

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