Market Vectors Gold Miners ETF (GDX): Cash Flow Is Key

Hard economic data has yet to show signs of imminent inflation, but the buoyancy of gold prices demonstrates an ongoing fear for the future. Investors seeking a safe haven from possible inflation, while still desiring to participate in any upward movement of the stock market, should consider Market Vectors Gold Miners (GDX), which tracks the stocks of gold companies. GDX hovered in the top five of our Sector Momentum Tracker ETF rankings from May 19 to June 30, indicating the appeal that gold continues to hold for investors worldwide.

Rather than owning actual physical gold, like SPDR Gold Shares (GLD) or iShares Comex Trust (IAU) does, GDX invests in the stocks of gold miners. While this strategy may not be as “pure” a gold investment, GDX offers investors leverage when it comes to gold prices. Because there are two forces at work, the cost of bullion and the costs of the companies that are mining it, GDX often rallies harder as gold prices rally, but it can sink faster if the costs of the companies outpace the profits from bullion. In 2009, leverage offered by GDX has helped this fund beat IAU and GLD. Year to date, GDX has risen 13.08%, while GLD and IAU have jumped 5.47% and 5.48%, respectively.

While GDX has beaten its peers thus far in 2009, investors should be mindful of the downside of this more volatile ETF. Rather than investing in a stockpile of pure gold, investors are essentially betting on the cash flow of the companies that make up GDX’s underlying basket. Investors must be mindful of fixed operating costs involved with gold miners as well as changes in currency valuations in the countries where the gold is mined and from which it is exported. GDX also has a large portion of its assets allocated to the fund’s top ten holdings, more than 68%, so investors should beware that movements in the fund’s top components could shake the price of the fund as a whole.

The economy has improved significantly in 2009, but several factors are still pushing many investors to establish or increase a position in gold. The housing market is still on life support as job losses continue to mount. Massive stimulus packages are pumping dollars into the economy and are slated to continue to do so into the future, adding to inflation fears. Investors have traditionally turned to gold in times of inflation, uncertainty, and crisis, and while these risks may have lessened somewhat as the market improves, they continue to offer compelling reasons for a gold investment. Since GDX reflects movements of the stock market more than its peers do, it may be the most appropriate investment for the “in transition” economic developments facing global markets.

In Australia, small gold miners have indicated a desire to merge into larger entities to gain more attention from investment funds, a recent Reuters article reports. The rising prices of gold, along with strong growth prospects for the miners, have helped to spur several deals, according to Reuters’ sources. Commenting on the merger prospects, Steve Robinson, a fund manager with Alleron Investment Management, noted, “Size does become an issue” and “For large investors, there is a bit of a constraint in the Australian market.” Alleron manages about A$1 billion in Australian shares, including Lihir Gold Ltd. (LGL.AX), the seventh-largest component in GDX and the second-biggest listed gold miner in Australia. The rising demand that is pushing these small Australian companies to merge is a good signal for GDX investors.

Goldcorp (GG), which constitutes 11.60% of GDX’s portfolio, issued its seventh monthly dividend to shareholders on July 6, underscoring continued growth in the company. While its current price may be a far cry from last year’s highs, GG’s issuance of 2% convertible notes in June has helped the company raise $862 million. Such GDX holdings as Goldcorp have accelerated production to meet demand but have also experienced higher costs for facilities and equipment. GDX’s components will have to continue to raise money in the latter part of 2009 to meet operating costs.

While inflation remains a concern for many investors, solid data proving immediate risk of inflation is currently absent. The price of ETFs like GLD and IAU will be tied more closely to the value of the dollar in the short term, limiting returns for investors if the currency remains stable. Gold has yet to sustain a major price decrease this year, even in the midst of an improving global economy. GDX is only appropriate for a small portion of a well-diversified portfolio, but if inflation speculation begins materializing and uncertainty continues to plague the economy, this ETF could play an important role.

Comments

[Ryu Mei Co:]

It is hard to buy and hold any Gold stocks at this price level, especially with so many uncertainties arising in the market lately. GDX is definitely something to consider when opportunity arises. Thanks for the info.

Jul 08 08:49 PM

[Rakesh V:]

I would suggest the Gold miners not to hold the any gold stock in their portfoloi as we know that they are giving less return ,

Mostly the cash cost of mines decreaed in last few months....increased the supply of gold mines

Jul 09 03:28 AM

[Gold Driver:]

strong portfolio...should of had a pretty decent day after earnings reports came out for ABX and GG

Jul 31 10:55 AM