Gold's Ascent to $3,500: Why Physical ETFs Outshine Leveraged Bets Like UGL

As gold nears the symbolic threshold of $3,500 per ounce, fueled by geopolitical tensions and inflationary pressures, investors are turning to gold ETFs to capitalize on the metal's safe-haven appeal. Yet, amid this surge, a critical divide emerges between leveraged derivatives-based ETFs like the ProShares Ultra Gold ETF (UGL) and traditional physical gold ETFs such as SPDR Gold Shares (GLD) or iShares Gold Trust (IAU). While UGL promises amplified exposure to gold's daily price swings, its structural risks—particularly counterparty exposure and liquidity fragility—make it a precarious choice for long-term investors. In contrast, physical gold ETFs offer a safer, more reliable hedge against systemic risks, even as short-term volatility tests market nerves.

The Structural Divide: Derivatives vs. Physical Gold

UGL's design is inherently different from its physical peers. The ETF aims to deliver 2x daily leveraged exposure to gold through futures contracts and swaps, a strategy that demands constant rebalancing to maintain its leverage ratio. This approach introduces two critical risks:

1. Compounding Volatility: Because UGL resets its exposure daily, its returns diverge sharply from a simple 2x multiple of gold's price over longer periods. For instance, if gold rises 10% over five days but fluctuates daily, UGL's cumulative return could lag due to the mathematics of geometric compounding.
2. Counterparty Risk: UGL's derivatives are tied to financial counterparties—banks, brokers, or clearinghouses—that could fail to meet obligations during a crisis. While physical ETFs hold gold bullion in insured vaults, UGL's investors rely on the creditworthiness of third parties.

Liquidity: A Double-Edged Sword

UGL's daily trading volume often rivals that of GLD, but its liquidity is conditional on market conditions. During periods of extreme volatility—such as a sudden geopolitical escalation or a liquidity crunch—derivatives-based ETFs can face compressed bid-ask spreads or delayed settlements. For example, in March 2020, when markets collapsed, leveraged ETFs experienced sharp declines due to compounding losses, even as underlying assets stabilized.

In contrast, physical gold ETFs like GLD benefit from structural liquidity. Their large asset bases ($82 billion in GLD's case) and daily gold auctions ensure that shares can be created or redeemed efficiently.

Geopolitical Risks and the Case for Physical Gold

As tensions over Ukraine, Taiwan, or energy supplies escalate, the demand for gold as a “crisis hedge” rises. Here, physical ETFs shine:
- Direct Exposure: GLD and IAU hold gold bullion directly, eliminating the risk of default on derivatives.
- Stress-Tested Performance: During the 2008 financial crisis and the 2020 pandemic crash, physical gold ETFs held up better than leveraged products.
- Central Bank Demand: Global central banks, which have added over 1,000 tons of gold to reserves in 2024 alone, prefer physical metal. This institutional demand reinforces the credibility of ETFs backed by real assets.

UGL, however, faces a dual challenge:
1. Futures Roll Cost: Gold futures often trade at a premium to the spot price (a phenomenon called contango), eroding returns. Over a year, these roll yield losses can offset gains from gold's appreciation.
2. Regulatory Scrutiny: U.S. regulators have warned that leveraged ETFs are not suitable for buy-and-hold strategies. ProShares explicitly advises UGL holders to monitor their positions daily—a requirement incompatible with long-term investing.

The Investment Call: Prioritize Physical ETFs

For most investors, the choice is clear: physical gold ETFs are superior for long-term haven exposure. Their minimal counterparty risk, liquidity stability, and direct link to gold's price make them ideal for diversification. UGL, while useful for short-term traders, should be avoided by those seeking protection against systemic risks.

The data underscores the cost advantage: GLD's 0.40% expense ratio versus UGL's 0.95% fee amplifies the drag on returns over time.

Conclusion

As gold approaches $3,500, the stakes for investors are higher than ever. While leveraged ETFs like UGL may tempt those chasing volatility, their structural flaws—compounding risk, counterparty exposure, and liquidity dependency—make them unsuitable for anything beyond active trading. Physical gold ETFs, with their tangible assets and proven resilience, remain the gold standard for long-term portfolios. In an era of geopolitical uncertainty, safety isn't just a priority—it's a necessity.