Value Trap Underneath Gold Miner Fund GDX

Divergence of earnings in the gold mining sector masks risks.

Reviewed by: Dave Nadig
Edited by: Dave Nadig

Divergence of earnings in the gold mining sector masks risks.

Yesterday was a serious gut check for investors in the mining sector. Is there a knife to catch?

There are charts and there are charts. But there’s no way to parse this one as anything but ugly:


I’m not a big believer in technical analysis, but I know an awful lot of traders are, which means a lot of folks are looking at the line for Market Vectors Gold Miners ETF (GDX | B-69) and seeing it plow through its resistance, with nothing to support it but “air” here.

So what are the lessons to learn here?

1) Gold Miners Are Volatile

It doesn’t take math to look at the difference between the lines on this chart and pick out the craziest one. I picked GDX as one of my ETFs to rally in 2014, and while that was still a solid call until a few days ago, it’s now looking pretty darn terrible. On a year-to-date basis, GDX is down just over 7 percent. Just this August, GDX was up more than 30 percent on the year.

2) Gold Miners Are Still Companies

Yes, there’s a significant correlation between the price of gold and the performance of gold miners. Consider this graph of the monthly correlations between GDX and the SPDR Gold Trust (GLD | A-100):



Certainly, more often than not, GDX and GLD will move in the same direction, but that relationship breaks down all the time, and it breaks down very, very quickly when it does. And because GDX is made up of companies run by human beings, there are far more things at work than just the price of gold.

Which brings me to:

3) Equities Are Ultimately About Earnings

If you look at the holdings of GDX, you find, as you might expect, significant winners and losers. Detour Gold Corp., a relatively small Canadian miner, is about to turn profitable for the first time, and is up almost 100 percent on the year. That’s helping offset once-profitable Coeur Mining, which is down more than 61 percent on the year on rapidly declining revenues.

See the picture there? Gold miners, perhaps more than any small niche I can think of, are a collection of wild fortune-telling cards. That’s part of the allure of gold miners—that one might “hit it big” and all of a sudden have vastly more gold, or higher production than you might expect. Unfortunately, it cuts both ways.

4) Gold Is About Currency

The last point, which I think many folks forget, is that gold is a weak-dollar play.

Any time you trade in your dollars to hold something, you’re effectively saying, “I’m shorting the dollar to buy X.” Gold in particular lives in an odd crux between currency and commodity. But since it’s priced in dollars, you should expect that, all else being equal, a strong dollar means you can buy more gold per dollar; that is, the price of gold should go down as the dollar gets stronger.

This chart tracks the price of gold (XAU) relative to the U.S. Dollar Index (DXY):



It’s hardly a perfect relationship, but it’s safe to say that it’s very hard for gold to rally at the same time the dollar is rallying. It’s the same pressure we have on oil prices, and frankly all commodities at the moment.

Fishing For Value

I am quite sure that there will be plenty of ETF investors who see a few terrible days in a solid ETF like GDX and are tempted to pull the trigger.

My only concern would simply be this: If you head to the Van Eck website and look at GDX, you see a reported price-earnings ratio for the stocks in the portfolio of 18.54. That makes it look like plain-vanilla large-cap equities—after all, the S&P 500 has a P/E right now of about 18.6.

But that belies the fact that a huge portion of GDX holdings are actually losing money. From companies like Newcrest Mining (5 percent of the portfolio) to Royal Gold (4 percent) to little Silver Standard Resources (0.35 percent), all those losses add up, making the true P/E—not magically forgiving the losses—negative 12. Far from value, gold miners are looking like a wildly speculative bet at the moment.

So just be careful when you’re reading those fact sheets on your value hunt.



At the time this article was written, the author held no positions in the securities mentioned. You can reach Dave Nadig at [email protected] or on Twitter @DaveNadig.

Prior to becoming chief investment officer and director of research at ETF Trends, Dave Nadig was managing director of Previously, he was director of ETFs at FactSet Research Systems. Before that, as managing director at BGI, Nadig helped design some of the first ETFs. As co-founder of Cerulli Associates, he conducted some of the earliest research on fee-only financial advisors and the rise of indexing.