As gold enters into a season of fundamental strength and what should be a powerful new upleg, there ought to be rekindled interest in gold stocks. In fact, if gold indeed rallies the gold-stock sector will likely see a much-more-powerful upleg than the metal considering how oversold it’s been. And one of the first places investors will go when they are drawn to this sector is the venerable GDX Gold Miners ETF.
GDX was the first gold-stock ETF when it was born in 2006. And with net assets of nearly $8.0b, today it is the largest of its kind. GDX’s strong correlation history with gold has made it a popular destination for institutional investors and hedge funds, while also being a hot spot for the casual retail investor looking to hedge individual-company risk. And of course GDX’s primary allure is its ability to positively leverage the underlying metal, really the only reason to own any gold stock.
While this leverage is fantastic over the course of a secular bull, it can be a double-edged sword. Even in a secular bull there are periods of weakness, whether a short-lived correction or an extended cyclical bear. And it is during these spells that leverage can work to the downside. To illustrate the two faces of leverage, take a look at this 12-month chart of GDX and gold.
As anyone in the gold-stock sector can attest to lately, oversold is an understatement. And GDX was certainly not immune to the carnage. But before we take a look at GDX, we must look to its primary driver. And gold was indeed party to a massive correction following its August 2011 all-time high hear $1,900.
Following an early-2012 bump back up to nearly $1,800, gold uncharacteristically spent the majority of late winter and early spring sliding lower. And by the time all was said and done, it fell nearly 19% to its mid-May capitulation low.
This obviously didn’t bode well for gold stocks, and from its all-time high in September 2011 GDX saw a 40.8% loss in only eight months. This was negative leverage at its best! Gold stocks were the pariahs of the markets, and only sellers could be found. And to show how oversold they truly were, at its May low GDX was trading at 2006 levels, when gold averaged about $600.
Thankfully GDX’s May low matches perfectly with gold’s own, and it appears as though a bottom has been carved. As you can see, gold has been gaining strength as we enter into its buying season. And after languishing in the summer doldrums, GDX has also come to life. With a 14% gain just in the last month or so it has not only responded to gold with positive leverage, it is hopefully forming the early stages of a glorious new upleg.
If we do see a major rally in gold stocks, this ETF has the potential to attract a lot of capital as investors return. GDX is very important in giving this sector exposure. And it can be especially important to its component companies by attracting capital that may not have otherwise come their way. So as a research guy I put on my research hat to dig a little deeper than the charts. What are investors getting when they buy this ETF? Are they getting the best this sector has to offer?