2024-01-11 23:49:37 ET
Summary
- The VanEck Junior Gold Miners ETF provide exposure to small-cap gold and silver companies.
- Although I am bullish on the long-term prospects for gold and silver prices, I do not believe junior gold miners is the right way to express this view.
- Simply put, mining is a tough business that few people realize. There are a million and one ways that investors in junior gold miners can get burned.
Although I have a long-term bullish view on gold and the price of precious metals, I do not believe the VanEck Junior Gold Miners ETF ( GDXJ ) is the best investment vehicle for long-term investors.
Few investors truly realize how tough the mining business can be. Operationally, junior miners tend to have less access to capital, fewer assets to backstop production and cash flows, and less capable management teams. This leads to long-term underperformance compared to senior miners and the underlying commodities.
I recommend investors bullish on precious metals to stick with royalty companies and the commodities themselves for better long-term returns.
Fund Overview
The VanEck Junior Gold Miners ETF provides targeted exposure to small-cap companies that are involved primarily in the mining for gold and/or silver.
Index Methodology
The GDXJ ETF tracks the MVIS Global Junior Gold Miners Index ("Junior Gold Miners Index"), an index that measures the performance of public small-cap companies active in the gold and silver mining industry.
Stocks eligible for the Junior Gold Miners Index must derive at least 50% of their revenues from gold and/or silver mining/royalties/streaming and/or have mining projects that can generate 50% of revenues from gold and/or silver mining in the future.
To be selected for inclusion, companies operating in the gold and/or silver mining space are sorted by their full market capitalization, and the companies covering the top 60% of industry market capitalization are excluded. Only companies between 60% to 98% of market cap are included in the index, although once added to the index, existing constituents can have their market cap range between 55-60% and 98-99% before being ejected. If there are less than 25 members in the index, the index provider may add additional companies until the number of constituents exceed 25.
The Junior Gold Miners Index utilizes a '7% Weighting' scheme where the largest 5 stocks by market cap are assigned weights of 7%, 6.5%, 6%, 5.5%, and 5% respectively. The aggregate 70% weight of the remaining stocks are assigned according to their market cap, with single stock maximum of 4.5%. Furthermore, the maximum weight for an individual silver stock is 4.5% and the weight of silver stocks in total must not constitute more than 20% of the index.
The Junior Gold Miners Index is rebalanced quarterly and the components are reviewed semi-annually in March and September.
Although GDXJ's index methodology appears confusing, VanEck has been very successful in raising assets, with the GDXJ ETF having $4.1 billion in AUM while charging a 0.52% net expense ratio (Figure 1).
Portfolio Holdings
The GDXJ ETF contains 98 securities. As designed, the GDXJ ETF focuses on smaller-cap gold miners, with 32% of the portfolio considered large-cap (>$5 billion), 50% considered mid-cap ($1-5 billion), and 18% of the portfolio small-cap (<$1 billion) (Figure 2). The weighted average market-cap of the portfolio is $3.2 billion.
Geographically, Canada features prominently in the GDXJ ETF, as 53% of the portfolio is domiciled in Canada. 19% of the companies are from Australia, and 4% are from Mexico and the United States, respectively (Figure 3).
The GDXJ ETF is a very concentrated thematic fund focused on junior gold miners with its top 10 holdings accounting for 45% of the portfolio (Figure 4).
Figure 4 - GDXJ top 10 holdings account for 45% of fund (vaneck.com)
Returns
However, historically, the GDXJ ETF has delivered poor performance, with 3/5/10 Yr average annual returns of -10.2%/5.9%/3.4% respectively (Figure 5).
Figure 5 - GDXJ historical returns have been poor (morningstar.com)
Unfortunately, GDXJ investors cannot blame the underlying commodity for the fund's poor performance. The SPDR Gold Shares ( GLD ), a passive ETF that simply holds physical gold bars, have returned 2.5%, 9.5%, and 5.5% p.a. over the past 3, 5, and 10 years, trouncing GDXJ (Figure 6).
Mining Is A Tough Business
Instead, I believe the issue of GDXJ's underperformance is simply because mining is a very tough business, with a multitude of ways in which investors can be burned. Geologically, only about 1 in 100 mining project goes from exploration drilling to an economic mine. Even fantastic drill results do not automatically translate into an economic deposit if the deposit is located in a remote location, for example.
Along the way, companies have to deal with operational risks like flooding (for underground mines) and processing equipment malfunction. Financially, miners have to deal with constant cost inflation in materials and labour, as well as a fluctuating commodity price. Geopolitically, companies have to contend with governments that like to raise royalty rates when commodity prices are rising, but not cut them when commodity prices decline.
Investors also have to contend with entrenched management that may be using the companies as their retirement funds, constantly issuing shares to raise capital to fund 'exploration' and mergers and acquisitions. Furthermore, junior mining companies tend to have less access to capital, higher cost of capital, less producing assets to diversify production and cash flows, and less competent management.
Increasingly, ESG is also becoming topical, as environmentalists worry about the damages from mining operations and strong-arm governments into shutting down important mines like Panama did recently with the Cobre Panama copper mine.
The culmination of all these risks is why fundamentally, I recommend retail investors gain exposure to precious metals via royalty companies like Wheaton Precious Metals Corp. ( WPM ). Royalty and streaming companies like Wheaton provide non-dilutive financing to mining companies in exchange for the right to purchase a certain percentage of a mine's output at below market prices ("streaming") or a royalty payment. While still exposed to the financial and geopolitical risks, at least royalty companies do not have to contend with a lot of the operational risks of mining. In fact, WPM is the only precious metals equity I personally hold in my portfolio, outside of physical bullion ETFs.
Historically, WPM has significantly outperformed GDXJ and the precious metal commodities over a trailing 1 year, 3 year, 5 year, and 10 year time horizon (Figure 7 to 10).
Figure 10 - GDXJ vs. WPM and peers, 10 years (Seeking Alpha)
Risks To Cautious View
The biggest risk to being cautious on the GDXJ ETF is 'missing out' on potentially large gains if/when precious metals rally. For example, in 2016 when the GLD and iShares Silver Trust ETF ( SLV ) rallied 8% and 15% respectively, the GDXJ zoomed higher by 73% (Figure 11).
Figure 11 - GDXJ vs. WPM and peers, 2016 performance (Seeking Alpha)
However, readers need to bear in mind that the GDXJ ETF had been crushed in the years before, suffering a 76% drawdown from 2013 to 2015, so a big percentage rebound was to be expected (Figure 12).
Figure 12 - But GDXJ was crushed prior to 2016 (Seeking Alpha)
Over the long run, I believe the business model of junior gold miners is simply inferior.
Conclusion
The GDXJ ETF provides concentrated exposure to junior gold and/or silver mining companies.
Although I am bullish on the long-term prospects for gold and silver, I simply do not believe junior gold miners are good long-term investment vehicles to express this view. I recommend investors stick with royalty companies with superior business models that are more defensive when times are tough but can also benefit when commodity prices go higher. I rate the GDXJ a hold .
For further details see:
GDXJ: Junior Gold Miners Underperform In The Long-Run