Contributed Commentaries
Concentrate on Healthy Junior Miner Trees Not the Diseased GDXJ Forest
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
Historically speaking, bull markets do everything in their power to continue higher without as many early participants on board as possible. It is the rare individual who can identify a trend early on, then remain fully invested atop the bucking bull until the “blow-off” stage that will reap him/her the largest gains.
The early stage of this new precious metal miner bull market continues to try and confuse sector investors any way it possibly can into being bucked off its back. The latest trick in the bull’s arsenal is the terrible underperformance of the Junior Miner Index Fund GDXJ in relation not only to gold, but to the Major Miner Index Fund GDX as well.
Historically, the miners lead the metals in either direction. Both the GDX, and the GDXJ have been lagging since gold made a higher low in early March of this year. However, the GDXJ has been very noticeably lagging both the GDX and gold.
The major miner fund GDX has blown past its respective 50-day moving average and has also reached the 200-day moving average. Meanwhile, the GDXJ has not come close to its 200-day moving average, let alone been able to penetrate its 50-day moving average for longer than a single day last week. The GDXJ has also broken its uptrend from the December low early this week, while the GDX remains firmly above its uptrend from the sector low put in back in December 2016 as I write this missive.
I have a few possible explanations for this recent underperformance, but first we need to examine the holdings in GDXJ. The two largest positions in this fund, which are collectively over 11% of the GDXJ, are NOT junior miners. The fund holds a 6.11% weighting in mid-cap producer Alamos Gold and a 5% holding of the VanEck sister ETF, the major miner fund GDX.
Furthermore, there are several other $2 – $3 billion market cap companies in this fund which many in the industry consider, with myself included, to be mid-cap producers. After calculating all the “non-junior” holdings, as well as the GDX weighting, this fund arguably holds just 55.7% in actual junior miners! I find it very misleading to have a weighting of nearly 40% in mid-cap producers and a 5% holding of a major miner ETF in a fund entitled “Junior Gold Miners ETF”.
Moreover, it seems the dichotomy between the GDXJ and the actual junior miner sector is about to get much worse. The popularity of the GDXJ ETF product has been so overwhelming it has forced VanEck (which runs both the ETF and index) to change the index rules to accommodate the increased demand.
According to a press release last week by VanEck, starting on June 17, "companies ranking between 60% and 98% (currently: between 80% and 98%) of the full market capitalization (of the investable gold miner universe) qualify for inclusion in the MVIS Global Junior Gold Miners Index."
Basically, what this means is the GDXJ is about to become even less like a “Junior Gold Miners Index Fund” than it presently is. Beginning on June 17th, even more higher market cap companies, which do not remotely resemble traditional “juniors” in the space, will begin to be added. These changes to the index will result in a dramatic transformation of GDXJ's portfolio, reducing the exposure it offers even further to the smallest junior gold miners. Scotiabank estimates that there could be as many as 23 new additions to the index (four of which are already in the ETF) which could represent 60.8% of the new index portfolio.
Additionally, the fund has reached regulatory limits in the amounts of shares it can hold in some companies. According to BMO Capital Markets, there will be a massive rebalance trade around the GDXJ ETF alteration in June as well as a large selling of existing GDXJ names. The ETF will need to sell $3 billion worth of its existing holdings to buy the new additions, which will create a massive funding trade significantly impacting existing names.
This is already causing some temporary selling in some well-known gold stocks, and buying in others. So, investors should be prepared for a few more months of possible GDXJ underperformance based on these upcoming changes to the fund.
If you currently hold any of the companies which are included in the GDXJ, you should be aware of the percentage this “junior miner” fund owns and psychologically prepare for the volatility these up-coming changes may have on the share price.
The scheduled changes to the GDXJ has also prompted Direction Funds to announce last week on April 13th, to suspend until further notice, daily creation orders in the 3x GDXJ daily direction derivative fund JNUG. The suspension has been temporarily taking away a percentage of the intra-day premium this ETF offers to day-traders.
Another likely reason for the recent underperformance of the GDXJ can be also attributed to rising volatility in JNUG. This highly volatile directional sector trading vehicle is becoming very popular with momentum focused day-traders. So much so that JNUG now represents 53% of GDXJ’s inflows/outflows. The GDXJ fund manager must purchase/sell many of its holdings based on these inflows/outflows, while JNUG just buys options/futures on the single ETF it leverages.
I feel JNUG, along with the three other 3x directional miner sector trading vehicles JDST, NUGT, and DUST, are distorting the entire precious metal mining sector and should be avoided at all costs by investors. There is already plenty of leverage in the miners for investors without trying to time the sector with these dangerous trading vehicles.
Based on the current holdings as well as these up-coming changes, it is my contention that the “Junior Gold Miners Index Fund” GDXJ is no longer a reliable barometer for the junior miner sector.
In a recent Bloomberg article about the rising popularity of the GDXJ, Alan Gayle, a senior strategist who helps oversee $42 billion in assets at RidgeWorth Investments in Atlanta stated: “This is a broad perception that ETFs are the easy way to invest in a theme without devoting the time and effort to analyze the individual component firms. As ETFs penetrate smaller and more specialized themes, they run the risk of actually distorting the market they are trying to mimic.”
I strongly believe this phenomenon is in the process of happening to the precious metal junior miner sector.
Meanwhile, the quality junior miners which are NOT included in the GDXJ continue to flourish and bifurcate from the sector. It has been my contention in past missives that investors should be concentrating on these junior developers/explorers and cashed up early stage exploration companies in order to maximize returns going forward in the new precious metal miner bull market.
Since late 2015, concentrating on the junior miners has been my major investment strategy as I maneuver my way through this new gold miner market cycle. Last year, I had a junior miner portfolio gain of 99%, and so far this year, I have a 25% gain.
