Gold Juniors’ Q2’17 Fundamentals

The junior gold miners’ stocks have spent months grinding sideways near lows, sapping confidence and breeding widespread bearishness. The entire precious-metals sector has been left for dead, eclipsed by the dazzling Trumphoria stock-market rally. But traders need to keep their eyes on the fundamental ball so herd sentiment doesn’t mislead them. The juniors recently reported Q2 earnings, and enjoyed strong results.

Four times a year publicly-traded companies release treasure troves of valuable information in the form of quarterly reports. Companies trading in the States are required to file 10-Qs with the US Securities and Exchange Commission by 45 calendar days after quarter-ends. Canadian companies have similar requirements. In other countries with half-year reporting, some companies still partially report quarterly.

The definitive list of elite junior gold stocks to analyze used to come from the world’s most-popular junior-gold-stock investment vehicle. This week the GDXJ VanEck Vectors Junior Gold Miners ETF reported $4.0b in net assets. Among all gold-stock ETFs, that was only second to GDX’s $7.5b. That is GDXJ’s big-brother ETF that includes larger major gold miners. GDXJ’s popularity testifies to the great allure of juniors.

Unfortunately, this fame has recently created major problems severely hobbling the usefulness of GDXJ. This sector ETF has shifted from being beneficial for junior gold miners to outright harming them. GDXJ is literally advertised as a “Junior Gold Miners ETF”. Investors only buy GDXJ shares because they think this ETF gives them direct exposure to junior gold miners’ stocks.  But unfortunately, that’s no longer true!

GDXJ is quite literally the victim of its own success. This ETF grew so large in the first half of 2016 as gold stocks soared in a massive upleg that it risked running afoul of Canadian securities law. Most of the world’s junior gold miners and explorers trade in Canada. In that country, once any investor including an ETF goes over 20% ownership in any stock, it is deemed a takeover offer that must be extended to all shareholders!

Understanding what happened in GDXJ is exceedingly important for junior-gold-stock investors, and I explained it in depth in my last essay on juniors’ Q1’17 results. GDXJ’s managers were forced to reduce their stakes in leading Canadian juniors. So last year capital that GDXJ investors intended to deploy in junior gold miners was instead diverted into much-larger gold miners. GDXJ’s effective mission stealthily changed.

Not many are more deeply immersed in the gold-stock sector than me, as I’ve spent decades studying, trading, and writing about this contrarian realm.  These huge GDXJ changes weren’t advertised, and it took even me months to put the pieces together to understand what was happening. GDXJ’s managers may have had little choice, but their major direction change has been devastating to the junior gold miners.

Investors naturally poured capital into GDXJ, the “Junior Gold Miners ETF”, expecting to own junior gold miners. But instead of buying junior gold miners’ shares and bidding up their prices, GDXJ was instead shunting those critical inflows to the much-larger mid-tier and even major gold miners. That left the junior gold miners starved of capital, as their share prices they rely heavily upon for financing languished in neglect.

GDXJ’s managers should’ve lobbied Canadian regulators and lawmakers to exempt ETFs from that 20% takeover rule.  Hundreds of thousands of investors buying an ETF obviously have no intention of taking over gold-mining companies! And higher junior-gold-stock prices boost the Canadian economy, helping these miners create valuable high-paying jobs. But GDXJ’s managers instead skated perilously close to fraud.

This year they rejiggered their own index underlying GDXJ, greatly demoting most of the junior gold miners!  Investors buying GDXJ today are getting very-low junior-gold-miner exposure, which makes the name of this ETF a deliberate deception.  I’ve championed GDXJ for years, it is a great idea. But in its current sorry state, I wouldn’t touch it with a ten-foot pole. It is no longer anything close to a junior-gold-miners ETF.

There’s no formal definition of a junior gold miner, which gives cover to GDXJ’s managers pushing the limits. Major gold miners are generally those that produce over 1m ounces of gold annually. For years juniors were considered to be sub-200k-ounce producers. 300k ounces per year is a very generous threshold. Anything between 300k to 1m ounces annually is in the mid-tier realm, where GDXJ now traffics.

That high 300k-ounce-per-year junior cutoff translates into 75k ounces per quarter. Following the end of the gold miners’ Q2 earnings season in mid-August, I dug into the top 34 GDXJ components. That is just an arbitrary number that fits neatly into the tables below. While GDXJ had a whopping 73 component stocks in mid-August, the top 34 accounted for 81.5% of its total weighting. That’s a commanding sample.

Out of these top 34 GDXJ companies, only 4 primary gold miners met that sub-75k-ounces-per-quarter qualification to be a junior gold miner! Their quarterly production is highlighted in blue below, and they collectively accounted for just 7.1% of GDXJ’s total weighting. And that isn’t righteous, as these include a 126-year-old silver miner, a mid-tier miner with temporary production declines, and a ramping mid-tier producer.

GDXJ is inarguably now a pure mid-tier gold-miner ETF. That’s great if GDXJ is advertised as such, but terrible if capital investors explicitly intend for junior gold miners is instead being diverted into mid-tiers without their knowledge or consent. The vast majority of GDXJ shareholders have no idea how radically this ETF has changed since early 2016.  It is all but unrecognizable, straying greatly from its original mission.