Why GLD And GDX Are Completely Unrelated

August 17, 2011

GLD is up 28 percent over the past six months. GDX is up just 5 percent. What gives?

The short answer is that, despite both common sense and common understanding, the two products are completely unrelated over the short term. Always have been and probably always will be.

The commonly held belief among gold investors is that gold mining stocks provided leveraged exposure to the price of gold. The rationale was simple: If gold rises, the gold mining shares would rise in greater proportion. After all, the cash cost of mining has been consistently below the price of gold, making each incremental increase in gold prices a de facto expansion of profit margins. Sounds simple, right?

Unfortunately for ETF investors, this simple strategy has not worked. As you can see by the chart below, gold’s meteoric rise (shown by the SPDR Gold Shares (NYSEArca: GLD)) has been met with tepid performances in both the blue-chip Market Vectors Gold Miners ETF (NYSEArca: GDX) and small-cap-focused Market Vectors Junior Gold Miners ETF (NYSEArca: GDXJ). Over that span, GDX is up just 5.2 percent, while GDXJ is actually down 6+ percent.

GDXJ vs. GDX vs. GLD (Feb. 16 - Aug. 16, 2011)

This result is contrary to most people’s expectations. For the past six months at least, the higher the expected beta to gold, the worse the performance has been. What’s happening here?

The most obvious answer is the market. The past six months have been chaotic, marked by heightened levels of volatility, market turmoil and geopolitical tension. The S&P 500 is down nearly 10.5 percent over this stretch, making the performance of the gold mining ETFs pretty good on a relative basis. This is of little consolation to those investors who were bullish on gold, yet chose to invest in the miners as opposed to the metal itself.

The reality is that gold mining shares are equities and they will behave as such regardless of what the gold itself is doing. In fact, GDX and GDXJ have shown shockingly low correlations to GLD over their respective histories. Since 2009, the return of GLD has only explained 10 and 15 percent, respectively, of the daily returns of GDXJ and GDX. This low correlation has persisted in the past six months, reiterating the idea that the price of gold has little bearing on the daily movements of gold mining ETFs.

For investors, the biggest takeaway is that a higher-risk portfolio will behave as such regardless of the performance of the most important input. In this case, the riskiest portfolio—GDXJ—performed the worst in a weak market, as one would expect.

In the end, gold miners may “catch up” to the price of gold. But for now, their risk is more likely to be measured relative to the market as opposed to the price of gold. It is never as easy as it seems.


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