What The Recently Announced Reverse Split In GDXJ Means For Shareholders

| About: VanEck Vectors (GDXJ)

As those holding gold and silver equities are all too familiar with now, gold and silver have been struggling since the year began, to say the least. In actuality, I'd say it has been a blood bath of red as the selling just doesn't seem to end. The losses have compounded adding to the decline from the highs in the fall of 2012. Year to date, the SPDR Gold Trust (NYSEARCA:GLD) and the iShares Silver Trust (NYSEARCA:SLV), the two most popular ETFs that track spot gold and silver prices, are down 23.4% and 35.6% respectively. The gold and silver miners, as measured by the Gold Miners Index (NYSEARCA:GDX), the Junior Gold Miners Index (NYSEARCA:GDXJ) and the Global X Silver Miners (NYSEARCA:SIL) have been hammered in the same time frame, down 48.8%, 55.9% and 50.1% respectively. Just writing this gives me an ill feeling, knowing that many investors have lost over half over their investments in these mining ETFs in such a short time. While I regard gold and silver as favorable investments for the long-term, this short-term pain is vicious. As such, Market Vectors, a leader in providing popular ETFs, announced on June 21, 2013 it will execute a reverse share split of GDXJ, which is a basket of holdings of junior gold and silver mining equities. As gold and silver have melted lower, other gold ETFs have undergone similar changes, such as the 1 for 5 reverse split of Direxion Daily 3X Gold Miner Bull ETF (NYSEARCA:NUGT). With the exception of this past week of trading, the broader bull market has powered ahead, taking nearly all sectors higher, except for precious metals and mining. This reverse split in GDXJ highlights the problems the stocks in the gold mining space have had, and Market Vectors believes that its post-split investment prices will be more attractive for buyers. The purpose of this article is to discuss specifically what this split means, how it affects GDXJ holders and what it means for the sector as a whole, including shareholders of comparable products.

Describing The Split

First, it is important to note that no other gold mining index will be affected by this split, such as GDX or NUGT, but some of Market Vectors' other products will be adjusted as well. The reverse split will be conducted at a ratio of 1 for 4 and will apply to shareholders of record at the close of the markets on June 28, 2013, and will begin trading at the adjusted price July 1, 2013. The ticker symbol for the fund will not change. The reverse split will increase the price per share of the fund with a proportionate decrease in the number of shares outstanding. In a 1 for 4 reverse split, every four pre-split shares held by a shareholder will result in the receipt of one post-split share, which will be priced four times higher than the value of the pre-split share. The following example best illustrates what to expect:

If you hold 1000 shares of GDXJ priced at $9.00 each, then after the reverse split you will hold 250 shares valued at $36.00 each. As you can see, the reverse split does not change the value of a shareholder's investment, it still remains $9,000.

Fractional GDXJ Shares

Shareholders who have quantities of shares that are not a whole number with an exact multiple of the reverse split ratio will be left with what is known as a fractional share. A fractional share will be created and affect any shareholder who does not hold a number of shares that is a multiple of four. After the reverse split occurs, fractional shares will be redeemed for cash and sent to your broker of record, generally within two to three weeks post-split. One issue to consider in this event is that redemption of fractional shares forces shareholders to realize either very tiny gains or losses, which could result in a taxable event in addition to having a potential loss on investment if prices are below where they were purchased. Given that the gold and silver markets are at three year lows and the miners are still searching for a bottom, a loss is a strong possibility with GDXJ. To avoid this scenario, investors can purchase more shares to round out their holdings to a multiple of four, or sell an appropriate number of shares to round out the holdings.

Options Holders

Options contracts are an important consideration as well. Traders who may be holding options on GDXJ should realize that this split will affect your contract(s), albeit minimally. Once Market Vectors conducts the reverse split, the contract undergoes an adjustment referred to as "being made whole." When contracts are adjusted to be "made whole", it simply means that the option contract is modified accordingly so that options holders are neither negatively nor positively affected by the split. While we know the reverse split will adjust the price of the underlying shares of the NUGT options, the options will be adjusted so that the changes in price due to the split do not affect the value of the options. The options clearing corporation will automatically adjust the price of all existing contracts to maintain the option market.

Estimating Contract Value

For those who want an estimate of what their current GDXJ option will be worth, the calculation is simple. Each GDXJ option contract is (usually) in control of 100 shares of GDXJ at some predetermined strike price. To find the new share coverage of the option after the split, all you do is simply take the split ratio and multiply by the old share coverage (normally 100 shares). To find the new strike price, take the old strike price and divide by the split ratio. Let's look at an example of a call option contract for 100 shares of GDXJ at a strike of $10.00.

Since the split is 1 for 4 we divide $10.00 by 1/4, generating a new strike price of $40.00. The option will now cover 25 shares because we multiply 100 by 1/4. Thus, your new call option contract which still expires on the same day as originally scheduled will be good for a purchase of 25 shares of GDXJ for $1000. On your brokerage account, the contract may be adjusted to read "GDXJ1" or similar and still state it is worth 100 shares at the original price, but for redemption purposes, the contract would be redeemed for 25 shares at the post-split price.

Implications For The Broader Sector

Unless you have been living under a rock, or have never traded gold or silver equities in your career, then you are all too familiar with the devastation shareholders have experienced in the last six months. Each day we have been seeing the gold miners struggle to find a bottom, but they really cannot do that until gold and silver find a bottom. Once $1300 was broken on gold and $20 was broken for silver, the next targets that need to hold are $1200 and $18.50 if we hope to see a bottom in the gold and silver miners. Nearly every firm has been calling for even lower prices. However, it is important to note that these are the same firms calling for $2500 gold and $50 silver back in early fall. Pay little attention to that nonsense. For holders of these equities and GDXJ in particular, realize that this reverse split is a symptom of the struggles the mining stocks due to the rampant negativity surrounding the miners. Fundamentally, at current metals prices, most companies cannot afford to stay in business. This could lead to supply issues down the road, if production is cutoff. Though pain may continue, for now, I would not capitulate and sell this far down. Those with high risk appetite could start to reestablish long term positions by pyramiding down into a full position (that is, buying in larger increments in 5-10% declines in the names of interest). GDXJ is down 55% in just six months, currently trading at $8.80. I personally believe this sell-off is a buying opportunity for long-term investors. In the short-term, there is more pain and volatility ahead. To bring the product to an investment price that Market Vectors believes is more attractive, it is conducting this reverse split. The reverse split of shares only really negatively impacts investors who own common shares at a total that is not a multiple of four, as they will be forced to sell fractional shares at a tiny loss, or a potential gain. Owners of options contracts will not be affected besides being faced with owning a new contract at a different strike price for a different number of shares. The total value of the contract will, however, remain the same. As the sectors has sold off, I would caution holders of similar funds, GDX, SIL and even NUGT to be prepared for their funds to potentially undergo their own reverse split.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I hold positions in various gold and silver miners, both long and short. I am holding the long positions through the turbulent times in gold and silver, with a minimum 10 year investment horizon.