Gold GDXJ Upside Bests GDX / Commodities / Gold and Silver Stocks 2019

Gold miners’exchange-traded funds are surging with gold powering higher.  These mounting gains are naturally fueling growinginterest in the leading gold-stock investment vehicles.  Traders looking to deploy capital are wonderingwhich major gold-stock ETF is superior, offering the best balance between upsidepotential, component fundamentals, and risks. GDXJ takes the crown, besting its larger big brother GDX.

By my count, there arecurrently 14 gold miners ETFs trading in US markets.  But that’s not authoritative, as the broader ETFindustry is constantly in flux.  These gold-stockETFs collectively held $17.5b in net assets as of the middle of this week.  And two major ETFs utterly dominated, commanding fully 85.1% of all those gold-stockinvestments!  They are of course GDX andGDXJ, which dwarf everything else in this sector.

The GDX VanEck VectorsGold Miners ETF and GDXJ VanEck Vectors Junior Gold Miners ETF hold net assetsof $10.6b and $4.4b, or 60.2% and 24.9% of American gold-stock ETFs’total.  They have a huge and likely-insurmountablefirst movers’ advantage, being birthed way back in May 2006 and November 2009respectively.  They’ve gradually built greatbrand recognition, even being viewed as primarysector indexes.

When hedge funds reporttheir equity holdings every quarter, if they have any gold-stock exposure GDXor GDXJ often top those lists.  When goldminers are discussed on CNBC, GDX and to a lesser extent GDXJ are used in chartsas sector benchmarks.  VanEck’s popularpair of leading gold-miners ETFs are well-known to investors and speculatorsinterested in this sector.  They areeffectively the only game in town.

With one companymanaging both GDX and GDXJ, and actively marketing them as a “Gold Miners ETF” anda “Junior Gold Miners ETF”, you’d think they are as different as their namesimply.  But unfortunately that’s not reallythe case.  GDX and GDXJ hold many of the same component gold miners, withmassive overlap in their holdings.  AndGDXJ’s definitely aren’t junior gold stocks, but actually larger mid-tier goldminers.

I’ve researched and writtenextensively on this.  Every quarter I wadethrough the latest results from the top 34 component stocks of both GDX andGDXJ.  The latest-available data is stillQ3’18’s, as the full-year reports including Q4 aren’t due until 60 to 75 daysafter year-end depending on companies’ market capitalizations.  As the recent Q3 earnings season wrapped up, GDXJ’s components were asubset of GDX’s.

GDXJ’s top 34 stocksaccounted for 82.9% of its total weighting. And fully 31 of these components were also GDX components.  These common gold miners across both ETFs weighedin at a massive 79.2% of GDXJ’s total weighting, and 31.7% of GDX’s.  So nearly 4/5ths of this “Junior Gold MinersETF” is made up by nearly 1/3rd of the major “Gold Miners ETF”.  GDXJ is now a mid-tier gold miners ETF, not a junior one!

It wasn’t always thisway, with GDXJ staying true to its advertised mission in its early years.  But GDXJ became a victim of its own successin the first half of 2016.  A young goldbull fueled skyrocketing gold-stock prices as traders flooded in to chase theirrallies.  GDXJ quickly grew so large thatit risked running afoul of Canadian securities laws, where most of the world’ssmaller gold miners’ and explorers’ stocks trade.

In the Canadian stockexchanges which are the center of the junior-gold universe, an antiquated ruleseverely hobbles ETFs.  Once any investorincluding ETFs acquires a 20%+ stake in any Canadian stock, it is legallydeemed a takeover offer that must beextended to all shareholders!  Americanstock-market capital flooding into GDXJ in early 2016 pushed many of itsCanadian-junior ownership percentages near 20%.

Obviously hundreds ofthousands of investors buying ETF shares have no intention of taking overgold-mining companies, no matter how big their collective stakes.  That’s a totally-different scenario than asingle corporate investor buying 20%+. Instead of lobbying Canadian regulators to exempt ETFs, GDXJ’s managerschose to unilaterally redefine what junior gold miners are.  Stakes in Canadian juniors were slashed.

For decades juniorswere often considered to be gold miners producing less than 200k ounces annually.  To give GDXJ the benefit of the doubt, Iconservatively expand that to 300k.  Thatworks out to 75k per quarter.  In Q3’18,only 3 of the top 34 GDXJ component stocks were primary gold miners that metthis junior threshold!  The rest were mid-tierminers between 300k to 1m ounces per year, and even 1m+ majors.

GDXJ made these missionchanges stealthily, knowing they would be controversial.  It took me quarters to piece this alltogether, and I was an outspoken critic of the “Junior Gold Miners ETF” nolonger being what it was billed as.  Butif you ignore the deceptive title, GDXJ has grown into an amazing mid-tier gold-miners ETF.  It owns lots of the world’s best gold miners,which are given much-higher weightings than in GDX.

The mid-tier goldminers producing between 300k to 1m ounces per year are in the sweet spot forstock-price upside.  Unlike the majorsover 1m which are struggling with production declines, the mid-tiers areexpanding existing mines and building new ones to boost their output and earnings. The mid-tier gold miners have smaller market caps too, making it mucheasier for capital inflows to bid up their stock prices.

Production is thelifeblood of the gold-mining industry, so traders often prize growth thereabove anything else when picking gold stocks. In Q3’18, the top 34 GDXgold miners including all the majors saw their total production decline 2.9% year-over-year to 9.5mounces!  That was stunning compared tothe World Gold Council’s read on overall global gold mined that quarter, which actuallygrew a healthy 1.9% YoY.

GDX is heavily burdenedby giant gold miners with shrinking production and high market caps, retardingits upside potential.  GDXJ has some similarproblems but to a lesser extent. Inexplicably GDXJ includes the major South African gold miners which are the worst in this industry for fallingproduction and high mining costs.  In Q3four of them weighing in at 13.1% of GDXJ’s weighting suffered sizable productiondeclines.

Excluding them and a fast-growingmid-tier gold miner that was oddly removed from GDXJ over the past year, therest of the top 34 GDXJ gold miners achieved strong 3.4% YoY production growth in Q3! All the growth in the gold-mining industry is now coming from themid-tier miners.  GDXJ not only holds thebest mid-tiers, but they have much-higher weightings than in themajor-dominated GDX.  GDXJ is the placeto be.

In addition to themid-tier gold miners’ growing production and lower market capitalizations, theirmining costs are in line with the majors. In Q3 the top 34 GDX gold miners averaged all-in sustaining costs of$877 per ounce.  The difference betweenthat and prevailing gold prices shows industry profitability.  The top 34 GDXJ gold miners had similar $911AISCs in Q3.  Without those South Africanmajors, it was $877 too.

So if you can get pastthe fact GDXJ certainly isn’t a “Junior Gold Miners” ETF, it is superior to GDXin every way.  The top 34 GDX stocksaveraged 288.8k ounces mined in Q3, while GDXJ’s top 34 came in 43% lower at163.3k.  That’s still far above the 75k conservativejunior threshold, but this mid-tier gold-miner range is where the vast majorityof world production growth is happening. GDXJ action reflects this.

I’ve been writing aboutGDXJ outperforming GDX in my quarterly-results essays and newsletters for thebetter part of several years now.  Butuntil this week I hadn’t done the work to formally quantify GDXJ’s superior upside.  I’ve been curious about it for some time, andhave received more questions on it with gold stocks powering higher again.  So I dug into this gold-stock bull’s GDXJ andGDX performances so far.

Since gold miners’stocks are exceedingly volatile, bulls and bears in them are often delineated insteadby gold itself.  Today’s gold bull was bornin December 2015 before surging in a powerful upleg in the first half of 2016.  While gold has suffered a couple of seriouscorrections since, it never crossed that -20% new-bear threshold.  So with gold in a continuous bull market for3.1 years now, so too are the gold stocks.

They are effectively leveraged plays on gold sincegold-mining profits directly amplify underlying moves in gold.  The major gold stocks of GDX generally leveragegold uplegs and corrections by 2x to 3x. So if gold rallies 10%, GDX usually climbs 20% to 30%.  Since GDX has become the leading benchmark forthis entire sector, GDXJ’s performance is best considered relative to GDX’s.  This chart summarizes it all.

GDX and GDXJ were bothhammered to fundamentally-absurd all-time lows back in mid-January2016 soon after gold’s own 6.1-year secular low.  Ever since gold stocks have meandered in aseries of bull-market uplegs and corrections. The performances of GDXJ and GDX in these recent years are rendered inblue and red below.  Key stats are shownfor each major gold ETF’s uplegs and corrections during that span.

The vertical light-bluelines divide up GDXJ’s uplegs and corrections, which generally match GDX’s butsometimes see major lows or highs out of sync. Each GDXJ upleg or correction shows GDXJ’s total gain or loss, the timethat move took in months, GDX’s corresponding move over that identical span,and GDXJ’s leverage to GDX in yellow.  The actual full GDX uplegs and correctionsare also shown below in red.

Even in today’s young, delayed,mostly-unpopular, and weak gold-stock bull, GDXJ has outperformed GDX by a widemargin.  And that’s despite GDXJ morphingfrom being a true junior-gold-miner ETF in the first half of 2016 to a mid-tiergold-miner ETF over the subsequent year.  Even holding bigger gold miners, theirsuperior fundamentals to the struggling majors have enabled GDXJ to keep theperformance crown.

In just 6.4 months inlargely the first half of 2016, gold stocks as measured by GDX skyrocketed 151.2%higher on a 29.9% gold upleg.  GDXJ well-outperformedGDX in roughly that same span, blasting 202.5% higher in 7.0 months!  GDX actually rallied 146.6% within GDXJ’s exactupleg, showing the mid-tier gold-stock ETF leveraged the major gold-stock ETF’smassive upleg by a solid 1.38x.  GDXJ’s upside bested GDX’s.

Gold’s powerful initialupleg was followed by a massive correction in the second half of 2016, where itplunged 17.3% after Trump’s surprise election victory unleashed a huge stock-marketsurge on hopes for big tax cuts soon. The gold-stock carnage as gold plunged was great, with GDXJ plummeting45.5% in just 4.1 months.  Interestinglythat leveraged GDX’s downside by 1.20x, much less than in the preceding upleg.

Ever since, the gold stockshave been mostly stuck in a big consolidation trading range.  Enthusiasm for this sector waned to nothingas general stocks kept powering higher in recent years which relegated gold todrift sideways as well.  While thisextraordinary gold-stock-bull disruption was highly unusual, it was the resultof record US corporate tax cuts levitating the stock markets.  That one-off event finally passed in 2018.

If you go through allthis gold-stock bull’s uplegs, GDXJ’s gains outpaced GDX’s by an average of 1.39x!  Ranging from 1.30x on the low side to 1.51xon the high side, there was not a single gold-stock upleg in recent years whereGDXJ didn’t majorly outperform GDX.  Taking GDX’s usual 2x to 3x leverage to goldand adding another 39% of marginal GDXJ gains on top of that is impressive.  What trader wouldn’t want that?

GDXJ’s much-superiorupside in this young bull is also accompanied by outsized downside relative toGDX during gold-stock corrections.  That’slogical, as bigger mid-tier gold-stock gains in preceding uplegs leave moreroom to sell off in subsequent corrections. Interestingly though, GDXJ’s downside leverage averaging 1.34x is a bitlower than its upside leverage in uplegs. That is skewed to the high side as well.

It ranged from a low of1.07x in the latest gold-stock selloff last summer and autumn to a staggering1.77x in spring 2017.  That outlier wasthe result of GDXJ’s gold miners surging far faster than GDX’s in early 2017.  Without that anomaly, GDXJ’s downside leverageto GDX during corrections averages only 1.20x. That is merely about half its upside leverage, so GDXJ’s added risks are disproportionally smaller than itsbetter upside.

Given all this, thereis really no reason to bother with GDX at all if you are deploying capital in majorgold-stock ETFs.  GDXJ has better mid-tiergold miners growing their production while trading at lower market caps thanthe struggling majors.  GDXJ hasdemonstrated much-better upside during gold-stock uplegs throughout this youngbull, yet its downside during corrections isn’t proportional.  GDXJ is far superior.

That being said, investorsand speculators are much better off avoiding these major gold ETFs entirely!  WhileGDXJ is nowhere near as bad as GDX, both are still burdened by major goldminers with declining production and rising costs.  It doesn’t make any sense to own suchlaggards when they can be avoided entirely in favor of mid-tiers and truejuniors with great fundamentals like growing production and stable costs.

The best strategy forriding this reaccelerating gold bull to wealth-multiplying gains in gold stocksis to carefully handpick the bestmid-tier gold miners mostly included in GDXJ. Every quarter I break out this ETF’s top 34 and lookat their production, costs, operating cash flows, earnings, and sales trendsamong others.  That exercise helps separatethe gold miners with better fundamentals from the lagging weaker ones.

So instead of justsettling and owning GDXJ, even-better gains are highly probable by sticking to mid-tiersand juniors with superior fundamentals. They rank lower in GDXJ’s weightings and are usually growing theirproduction organically or through new mine builds that recently came online orwill soon be live.  With plenty of greatgold miners in this sector, there’s simply no need to hold the laggardsretarding even GDXJ.

With gold stocks now enjoying a major upside breakout,massive new investment buying is coming. And the best gains by far will be won in smaller mid-tier and junior goldminers with superior fundamentals.  WhileGDXJ itself will power dramatically higher despite some deadweight in its holdings,the better gold miners will generate much-greater wealth creation.  Finding and owning these better gold-miningstocks is essential.

That’s one of my importantmissions at Zeal, relentlessly studying the gold-stock world to uncover thestocks with the greatest upside potential. The trading books in both our weekly and monthly newsletters are currentlyfull of these better gold and silver miners. Most of these trades are relatively new, added in recent months as goldstocks recovered from deep lows.  So it’snot too late to get deployed ahead of big gains!

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The bottom line is GDXJ’supside easily bests GDX’s.  While GDXJ isnow really a mid-tier gold miners ETF instead of the junior one advertised, itholds some of the world’s best gold miners. Unlike struggling majors which dominate GDX, plenty of mid-tiers are stillgrowing their production.  They enjoysuperior fundamentals and are weighted much more heavily in GDXJ than GDX,giving it much-better potential gains.

Throughout this entireyoung gold bull of recent years, GDXJ has well-outperformed GDX during gold-stockuplegs.  While that has also led tobigger downside during corrections, it is disproportionally small compared tothe upleg gains.  GDXJ simply offers superiorgold-stock sector exposure than GDX.  Butboth these major gold-stock ETFs are still burdened with laggards dragging downtheir overall performances.

Adam Hamilton, CPA

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