[Click all to enlarge]
Above is a three-month chart of the SPDR Gold Shares ETF (GLD) in blue, with the Market Vectors Gold Miners ETF (GDX) in red. Look at the divergence: Returns are about 17% better over three months for physical gold versus the miners.
Above is a chart comparing GLD and GDX since early September 2008, two weeks before the Lehman Brothers implosion. (Both charts courtesy of Yahoo Finance.) There is a great divergence in late 2008, with the mining stocks falling far behind the physical gold ETF as the broader market turned downward; but the miners managed to reach parity just after the March 6, 2009 bottom of 666 on the S&P. After an April stumble, the GDX maintains a reasonable parity from June 2009 all the way through April 2011, with a small hiccup in early 2010.
So what is causing the divergence? It should be noted that Barrick Gold (ABX), the largest component of the GDX at 15.3 percent, has fallen about 18% in recent weeks after buying Equinox Minerals for nearly $8 billion and then delivering first quarter results that, despite seeming solid, disappointed investors. Of course, this does not come close to explaining a 17% divergence on the whole.
So is the divergence based on fundamentals, or is the market making an error here in undervaluing miner stocks, given the continued strength in bullion? What is interesting is to take a similar look at the Market Vectors Junior Gold Miners ETF (GDXJ), and its three-month chart versus GLD:
The chart is nearly identical to the GLD vs GDX chart.
Lastly, let's take a look at the three-month chart comparing GLD (physical gold) with the mining stock ETFs GDX and GDXJ, plus the S&P 500 as a benchmark:
(My apologies for switching the chart; Yahoo Finance wouldn't run the four-stock chart.)
So, over three months, the two mining ETFs are both over 10% behind the broader market, despite the fact that bullion prices have risen with relatively low volatility. What are some possible explanations for this?
1. The forward-looking stock market doesn't believe that the price of gold will maintain its current price. It's possible that investors who want to short gold are going to the miners first, based on technical reasons or the fear of facing momentum traders in the underlying commodity. Stock traders shorting (or liquidating positions in) the miners have different motivations in their trades than commodity traders, and mid- to long-term investors may not have faith in the long-term price of bullion staying at current levels. We may simply be seeing a disconnect between short-term commodity traders and mid- to long-term stock investors.
2. There is a fundamental issue facing gold miners which will drive up expenses industry-wide, reducing potential profits even in the face of current prices. If there is, I don't know it. Certainly, as miners expand operations to meet higher demand (and gain higher prices in return), capital expenditures can impact short-term earnings and cash flow. But a rational market should price in the increased potential revenues over the long-term as mining operations expand worldwide.
3. The market has made a mistake, and this short-term gap between returns for physical gold and mining stocks offers a trading opportunity. A trader who is bullish on gold might consider turning to the GDX or GDXJ instead of the SPDR physical gold ETF, anticipating that returns for the stock-based funds will again return to levels approaching that of the GLD. As noted in the longer-term charts, GDX has consistently returned to a reasonable parity with the GLD, while the GDXJ has actually offered superior returns for most of its two-year history.
As the three-year chart shows, when the GDX has lagged the GLD, it has caught up repeatedly and usually quickly. Option traders can look at short-term calls for the GDX, such as the August 59 call, asked at 1.02, which needs a 6.6% rise to break-even.
When looking at potential investment ideas, I like to ask: "Is the market missing something, or is the market telling us something?" In this case, I'm honestly not sure. It would appear from historical price actions in these funds (and, as always, be aware that past performance does not necessarily predict future results) that there may be a trading opportunity in the GDX and GDXJ mining stock ETFs. But there may also be something that the market is telling us about the price of gold or the health of gold mining companies.