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The Lack of Leverage

The biggest issue in the gold sector right now is lack of leverage. Gold has had a great month, gaining 5.2% since May 7th, but gold stocks have barely provided leverage to those gains. The ETF of gold majors, GDX, is up just 8.9% and the junior ETF brother, GDXJ, is up just 11%.

Leverage is the fuel that feeds investment in this volatile sector. Without leverage, why would any of us invest in gold stocks? Gold alone is risky enough, what with it reacting to such a range of economic and political events. Gold stocks add exploration, development, or mining to that equation, multiplying the risk.

The only reason gold bulls invest in stocks, then, is because miners are supposed to provide leverage to the metal’s upside moves. But of late that leverage has been missing. What gives?

I think there are two reasons.

One is a bit of stubborn disbelief. Gold investors are so used to Sell in May and Go Away, so used to a market that slides through the summer, that they are struggling to believe that gold’s gains are real. It doesn’t help that politics have played a major role in gold’s recent gains. Gold investors know well that political gains are the least reliable.

But politics ain’t the only factor at play. Take a look at these two charts.

The first is the dollar index, showing a greenback that has lost 6.3% so far this year, most of that in the last three months. A declining dollar will always help gold.

The second is the yield on 10-year Treasuries. Yields jumped in November following the election, when Trump optimism amped up yields and the dollar. But so far yields have spent 2017 giving that ground back, to sit today at just 2.17%.

Take inflation away from that, which is 2.2% for the 12 months up to the start of May, and we are back in the world of negative real interest rates.

Yes, the Federal Reserve is likely to raise interest rates in a week, which will put real rates just positive again. But there is limited reason to think that will hold. As I have said, either we’ll see growth, which will create enough inflation to keep rates low to negative assuming Yellen remains cautious with rate hikes (necessary given government and corporate debt loads), or we won’t see growth, in which case there both inflation and rate hikes will be negligible.

I attribute gold’s recent gains almost evenly to geopolitics and economics. Real rates really matter. If it costs, or even just doesn’t pay, to hold dollars, investors will turn to something that does pay.

And given all the fundamental reasons for gold to gain in the medium term – cyclicality, low to negative real rates, the potential for the US dollar or markets to turn down, and unpredictable politics around the world – gold fits that bill.

As this year-to-date chart shows, gold has been marching upward and marking out what looks to me like a confirmed uptrend, especially now that it has again reached $1,290 per oz. marking yet another higher high for the year.

So while politics keep grabbing headlines – that will continue with Comey’s testimony tomorrow, followed by the election in the UK and the escalating Qatar-focused stand-off in the Middle East – economics are playing just as much of a role in supporting the yellow metal.

Yet gold traders are struggling to accept that gold can maintain gains in a season when it’s supposed to slide and in a month when rate hike anticipation is supposed to push the price down. That hesitation is one reason gold stocks have been failing to provide leverage of late.

The other reason is the GDXJ rebalancing.

Remember, Van Eck is rebalancing its junior miner ETF because, when gold turned from bear to bull in early 2016, investors flocked to the ETF for exposure. As dollars flowed in, the fund had to keep deploying those dollars into holdings, buying more and more shares of its 57 component companies to keep the value of each stock holding equal to its percentage of the fund.

Eventually the buying pushed GDXJ’s holdings to almost 20% in some 18 companies. That just doesn’t work – a passive fund can’t own such a large position in a stock and most certainly can’t make a takeover bid, which is what a 20% stake is supposed to spark. Hence the decision to reduce all holdings to no more than 10% and add larger market cap companies to replace the shares sold. (Until now GDXJ has capped its arena to companies with market caps less than $1.5 billion; now it will invest in entities worth up to $3 billion.)

The details of the rebalance are still very unclear. We don’t know if Van Eck is already trading, so that the rebalance will be complete as of the June 16th deadline, or whether the fund has done no selling whatsoever as yet and will start the rebalance on that day. On Friday (June 9th) Van Eck is slated to make an announcement that might clarify such questions; perhaps Van Eck will even outline what it will be selling and buying.

The market gives no clues. Companies that the fund will clearly be selling (to cut ownership back below 10%) have lost ground since the news broke in April, but it’s impossible to know whether the losses are because GDXJ itself is selling or because investors are selling those stocks in advance of an expected GDXJ-selling slide.

But there are a lot of interlayered ripple effects here. Investors selling shares in companies like Gold Standard, where GDXJ holds more than 10% and therefore will certainly sell (or perhaps already has), has hurt the value of the ETF itself. Since the rebalance announcement in mid-April, GDXJ is down 11%. That loss in value requires the fund to sell shares across the board, which has only amplified losses.

Now for a point-form intro to three companies I like in this context:

  • MAG Silver (TSX: MAG). A solid silver developer. Like for the fundamentals and because MAG shares oscillate regularly, making this stock a good trading option. The fact the GDXJ is or will be selling MAG is helping create a good entry for what could be a long hold or (more likely) will be a trade.
  • Klondex Gold (TSX: KDX). A gold producer that has slid 40% since March, some of which is because of GDXJ selling pressure. A trade.
  • Alacer Gold (TSX: ASR). A Turkish gold producer that is off 25% since March and 40% since September. The reasons are both macro (gold, the GDXJ) and fundamental (the resource estimate disappointed, the mine expansion is slower than expected and oxide production less than expected). I see good odds that the worst of the fundamentals is over, just as the macro challenges likely also resolve.

None of these are official Maven portfolio holdings yet, as I will re-assess the situation after Van Eck’s announcement on Friday. But there’s a preview of where I am seeing opportunity.

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Gwen, you are truly a beacon of sound thinking and honest insight in a market sector full of charlatans.

-AH (September 2022)

I'm one of your new subscribers (by way of and just want to belatedly thank you for the recent sell recommendation that saved me quite a bit of money. (I also follow a few other mining newsletters, and, like so many other financial analysts, they were too hesitant and biased against putting out sell alerts.) And I find your newsletters very nicely done in general.

Kind regards!

-TA (April 6, 2020)