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 $1900.
Following an early-2012 bump back up to nearly $1800, 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 8 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?
As an ETF, GDX seeks to replicate the performance of an underlying index. And Van Eck Global, GDX’s administrator, chose the NYSE Arca Gold Miners Index. This index targets exposure to publicly-traded companies involved primarily in the mining of gold, and consists of a diversified blend of stocks across the size spectrum. And after looking at its holdings, GDX indeed offers exposure to some of the biggest and best gold stocks this sector has to offer.
As of this week GDX’s holdings consist of 30 stocks, with the top 16 combining to hold 90%+ of its value. All of these stocks list in the US, with most sporting a dual listing in Canada. The majority of GDX’s components are actual producers (25), with those that are not being either large juniors or royalty companies. And their operations are well diversified, scattered all over the world.
But knowing an ETF’s high-level facts is not enough. If investors really want to take ownership in what they own, I believe they need to get intimate with the major holdings of their ETFs. If anything it will give them confidence in their investments, while also allowing them to learn more about the inner workings of an industry. And doing a little research may even expose some weaknesses. Let’s find out a little bit about GDX’s top 10 holdings, in order of largest to smallest by weighting.
Barrick Gold (ABX - NYSE) 15.4%: How appropriate that GDX’s largest holding is the world’s largest gold producer. In 2012 Barrick Gold anticipates production of about 7.5m ounces, at total cash costs of around $560. Incredibly this tally accounts for nearly 9% of the world’s total mined supply, a huge sum.
On the operations front Barrick’s portfolio consists of 26 operating mines. These mines and its other advanced exploration and development projects reside on 5 different continents and hold a massive reserve base of 140m ounces of gold, 1.1b ounces of silver, and 13b pounds of copper!
Barrick has seen incredible growth over the years as a result of savvy acquisitions and organic discoveries. Its production volumes, reserves, net earnings, and cash flow have all skyrocketed. And it doesn’t plan on slowing down any time soon. Barrick’s pipeline includes its massive Pueblo Viejo (Dominican Republic) and Pascua-Lama (Argentina/Chile) mines that are currently under construction. And by 2016 these mines will increase Barrick’s total annual output to approximately 9m ounces.
As the largest gold company Barrick naturally has the largest market capitalization in the sector, at around $37b. And with its 15%+ weighting GDX is actually one of Barrick’s largest shareholders, owning over 3% of the company. Overall even though Barrick Gold is the leading senior gold miner, its size can be a knock against it. Unfortunately its large size can really throttle upside inertia. And judging by the recent sacking of its long-time CEO, Barrick’s lagging share performance has not gone unnoticed.
Goldcorp (GG - NYSE) 13.2%: Goldcorp is one of the world’s premier senior gold producers. Its 10 operating mines located in 5 different countries across the Americas are expected to produce about 2.4m ounces in 2012. And this gold, which is completely unhedged, is being produced at super-low cash costs of about $320.
Goldcorp has long been one of Zeal’s favorite gold stocks. It has a long history of superior management, with strong roots that were cultivated by industry legend Robert McEwen. This company was also one of the first to be bullish on gold at the beginning of today’s decade-old secular bull.
Goldcorp’s growth trajectory is also unmatched considering its market cap was just $50m in the early 1990s. And it has no plans of sitting on its laurels as it looks to the future. GG’s large reserve base of 65m ounces includes 8 development-stage projects that are expected to nearly double production to 4.2m ounces by 2016. Its pipeline really is second to none, highlighted by its share of the Pueblo Viejo mine and its spectacular Cerro Negro project in Argentina (550k ounces annually at sub-$300 cash costs).
Newmont Mining (NEM - NYSE) 9.9%: Prior to Barrick Gold’s acquisition of Placer Dome in 2006, it was Newmont Mining that had long held the world’s #1 spot in the global producer rankings. Newmont has since been relegated to the #2 spot. But with 2012 production volume projected at 5.1m ounces, it has a strong hold of it.
Operationally Newmont sports a diversified portfolio of projects that includes 30 operating mines on 5 different continents. It also has a strong pipeline of development projects that are expected to grow production to about 6.5m ounces by 2017. Its reserve base of 99m ounces is also quite robust, second only to Barrick.
Unique to Newmont is that it’s the only gold company listed on the flagship S&P 500 stock index. It is also a pioneer in how it spins out its cash flow, offering investors a gold-price-linked dividend. On the cost front Newmont’s $650 cash costs are a bit higher than its peers’, but it still has plenty of margin and remains quite profitable.
Overall Newmont Mining rounds out the big three of GDX’s major holdings. With Barrick, Goldcorp, and Newmont combining for well over one third (38%) of this ETF’s weighting, investors ought to take a keen interest in how these major producers fare.
Silver Wheaton (SLW - NYSE) 5.5%: With a name like Gold Miners ETF, I was quite surprised to see Silver Wheaton as one of GDX’s top holdings. And I was even more surprised to find out that SLW was one of 6 silver stocks that combine to hold 10% of GDX’s total weighting. But I really don’t see any problem with this considering silver’s high correlation to gold. And especially so since GDX’s biggest silver holding is one of the world’s best silver stocks.
Silver Wheaton is one of the most profitable silver companies on the planet, yet provocatively it doesn’t mine a single ounce of the metal. SLW is what is known as a streaming company, which is not to be confused with a royalty company. Its business model is actually quite brilliant, in that it pays miners an upfront sum for the right to purchase all or a portion of their future silver production at a low fixed price.
In 2012 Silver Wheaton is expected to have attributable silver-equivalent production of a whopping 28m ounces. If we scrub this up with the world’s primary silver miners, this makes SLW second largest behind only Fresnillo PLC. These ounces are mostly coming from primary gold and base-metals mines, 17 to be exact. And SLW is buying this silver at an average cash cost of just over $4.00. Even more astounding is SLW is expected to grow attributable production to 48m ounces by 2016, with only a modest increase in cash costs. This company is a cash cow!
Yamana Gold (AUY - NYSE) 5.0%: Yamana Gold is a company that we’ve been following at Zeal for a long time. This producer has seen incredible growth over the years, and currently operates 8 mines in Mexico, Brazil, Chile, and Argentina. These mines are expected to deliver 2012 gold-equivalent production of about 1.2m ounces, at super-low net cash costs of less than $250.
One thing that has impressed me with Yamana over the years is its ability to shift focus from acquisitive growth to organic growth. AUY’s stellar technical team has so far made four major discoveries that have all ended up being economically feasible to development. And these projects are expected to lead to a production increase of nearly 50% by 2014.
AngloGold Ashanti (AU - NYSE) 5.0%: With 2012 production expected to come in at about 4.3m ounces, AngloGold Ashanti ranks as the world’s third-largest gold miner. This global powerhouse owns 20 mining operations in 10 different countries. And its stock has long been a mainstay on most of the world’s gold-mining indices.
Unfortunately it has been a long time since AngloGold has found favor with investors. Among the chinks in AU’s armor is it was one of the last producers to reduce its hedges, its cash costs are typically on the high side (~$805 in 2012), and a large portion of its operations are located in South Africa (a brutally hostile place to mine during gold’s bull).
For these reasons and more AngloGold’s stock has struggled. And this is readily apparent when you compare its market cap to its peers. Incredibly at $12b AU’s market cap is less than that of Yamana, a company that produces just a quarter the gold. And amazingly its market cap is only about a third that of Goldcorp, a company that only produces about half the gold. This disparity speaks for itself!
Randgold Resources (GOLD - NASD) 4.8%: In addition to having the coolest stock symbol of all the gold stocks, Randgold Resources is a solid mid-tier gold producer. In 2012 it is expected to produce around 800k ounces of gold, at cash costs of around $640.
This production will come from 3 mines in Mali and one in Cote d’Ivoire. And with the addition of a large new mine currently being developed in the Democratic Republic of the Congo, production is expected to increase to 1.2m+ ounces by 2014. Randgold is an excellent African gold miner.
Kinross Gold (KGC - NYSE) 4.8%: Kinross Gold is one of the world’s top-10 gold producers, with 2012 gold-equivalent volume expected to come in around 2.5m ounces. KGC is well-diversified, with 10 operating mines on 4 different continents. And its reserve base is quite robust at 63m ounces.
Unfortunately Kinross is another major producer that has had its fair share of struggles over the course of gold’s bull. In addition to costs that are higher than most of its peers (~$700), KGC has had some growing pains. And its recent pains surround some of its recent acquisitions. In addition to a $3b goodwill impairment charge on the projects it acquired from Red Back Mining in 2010, KGC will be faced with major challenges in raising capex to expand and develop its large projects in Mauritania, Ecuador, Chile, and Russia.
Eldorado Gold (EGO - NYSE) 4.7%: Eldorado Gold is an excellent mid-tier producer that possesses the ability to successfully operate in countries that tend to hold higher degrees of geopolitical risk. EGO owns 7 mines in China, Turkey, Greece, and Brazil. And in 2012 they will combine to produce 660k ounces at cash costs in the lower quartile of industry average ($465). Eldorado also has ambitious growth plans, with a targeted annual rate of 1.7m ounces by 2016.
Agnico-Eagle Mines (AEM - NYSE) 4.3%: Agnico-Eagle Mines is another excellent mid-tier gold producer. Its 5 operating mines in Canada, Finland, and Mexico will combine to produce about 975k ounces in 2012. Cash costs are a bit on the high side at about $720, but this is hopefully only temporary as it optimizes production at its newest and largest mine. AEM also has a strong portfolio of exploration and development projects that should lead to material production growth in the years ahead.
In all, GDX’s top 10 holdings account for nearly three-quarters of its total weighting. The 9 gold companies collectively produce about 25m ounces of gold, which is the equivalent of about 30% of the total global mined supply. And with an average market cap of $16b+, owners of GDX are indeed taking a heavy stake in the largest gold stocks this sector has to offer.
GDX’s remaining 20 holdings are quite diverse. These companies include a wide range of major, mid-tier, and junior gold producers, and also several silver miners (5.0% of total weighting), royalty companies (2.9%), and non-producing juniors (>1.0%).
Overall GDX is a fantastic vehicle that gives investors excellent gold-stock exposure. And I would highly recommend this ETF for investors who have no desire to pick stocks and/or learn about this sector. But with a modified capitalization-weighted system applied to a sector that only has a small pool of large stocks, some of the dead weight up top can really throttle performance. Discretion is out the door when trying to mirror an index with this methodology.
For this reason prudent investors would be a lot better off picking their own basket of stocks. And it really doesn’t take much research to grasp an understanding of how to pick stocks in this sector. A high level scrub of financials, corporate presentations, and project portfolios will quickly separate the wheat from the chaff. If an ETF like GDX is capable of positively leveraging gold’s performance, imagine what a skillfully selected portfolio of stocks can do!
The bottom line is gold is likely in the beginning stages of a spectacular new upleg. And where gold goes, so usually do gold stocks. In fact, the beaten-down gold stocks are due for a major rally that ought to greatly leverage gold’s to the upside. And as measured by the venerable GDX Gold Miners ETF, this leverage is already underway.
GDX is likely to see a lot of interest as a new wave of investors is drawn to the gold-stock sector. This ETF offers exposure to some of the biggest and best gold stocks there are, while also hedging individual-company risk. But for investors who have the stomach to take on this risk, their chances of achieving even greater gains improve when they hand pick only the highest-quality high-potential stocks.
August 31, 2012
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