Gold Miners: Taking A Peak Under the Hood

October 07, 2010

Juniors have outperformed the large diversified miners—and even the price of bullion—this year. But are they worth the risk?


The risk trade is on again.

You can tell that by watching the Gold Miners Ratio, a fraction that compares the relative weight of the Market Vectors Gold Miners ETF (NYSE Arca: GDX) to its younger sibling, the Market Vectors Junior Gold Miners ETF (NYSE Arca: GDXJ).

The "senior" fund comprises 30 established gold producers, while the "junior" portfolio includes 60 issuers, mostly companies engaged in the exploration and development of gold properties.

The miners' ratio uses GDX's share price as its numerator, while the market value of GDXJ is the denominator. Presently, the ratio's in the 1.60 area, which is a historic low. Simply put, the price of the junior fund has been rising relative to the senior portfolio since July. Hence the risk.

Over the summer, investors, hoping for leveraged gains, were much more willing to suffer the vicissitudes of early-stage mining ventures. And why not? As illustrated in a previous article ("Are Gold Stocks Better For Your Portfolio?"), the junior fund handily outperformed the producer portfolio and even the price of bullion itself this year.


Gold Miners Ratio (GDX/GDXJ)

Gold Miners Ratio (GDX/GDXJ)


That doesn't necessarily mean the GDXJ portfolio was the best way for investors to obtain gold exposure. In fact, when overlaying a modest allocation of gold to a balanced portfolio of stocks and bonds, it doesn't really matter what kind of product you use. Junior stocks, producers' shares and bullion itself all foster the same portfolio return. Only the risk undertaken is different.

A fund is only as "good" as its component stocks. There's a vast difference—along several dimensions—between the stocks making up the junior portfolio and those comprising the producer product.

By comparing the top five constituents of each portfolio, we can get a better sense of the internal forces at work.


GDX - Gold Miners

YTDReturn AnnualVolatility DownsideSemivariance SharpeRatio Beta vs.Gold PortfolioWeight
Barrick Gold Corp. 23.4% 31.5% 18.4% .74 1.38 16.4%
Gold Corp. Inc. 14.8 33.7 19.2 .44 1.47 11.5
Newmont Mining Corp. 36.8 31.8 17.3 1.15 1.32 10.9
AngloGold Ashanti Ltd. 18.3 31.9 18.1 .57 1.33 5.9
Kinross Gold Corp. 6.3 35.1 20.5 .17 1.44 5.2
Mean 19.9% 32.8% 18.7% .61 1.39


By and large, there aren't real "standouts" among the top tier of gold producers. Most portfolio metrics, save for their Sharpe ratios, are fairly uniform. That shouldn't be too surprising for established companies.

But a couple of the metrics probably bear explanation.

Downside semivariance is the standard deviation of daily losses. It's often said that volatility is a two-edged sword: Upside moves are considered just as risky as downturns. Downside semivariance accounts for only the "bad" volatility. A skew in the semivariance metric from the stock's volatility midpoint gives an investor a better sense of the security's real risk. Note, for example, that the downside semivariance of Kinross Gold Corp. (NYSE: KGC) is more than half its annualized volatility. KGC was a stock more likely to have "down" days than "up days."

Sharpe ratios express a stock's risk-adjusted excess return; that is, its gains over a risk-free investment, factoring in its volatility. A ratio above 1.00 represents an excess return greater than the stock's risk.

Here, each stock's beta, or relative variance, is set against gold's. Positive readings indicate a directional correlation to bullion. A beta over 1.00 indicates the degree of excess volatility over gold's.


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