GDX vs. GDXJ: A Better Way To Play Gold?

by on March 3, 2010 | ETFs Mentioned:

A recent survey released by InvestmentNews highlighted the ten ETFs financial advisors researched the most, based on data provided by Morningstar. It’s tough to know exactly what to make of the list, but at the very least it gives some interesting insights into the minds of investors. The list included many of the usual suspects: the S&P 500 (SPY), emerging markets (EEM and VWO), aggregate bond markets (AGG and LQD) and diversified commodity funds (DBC) were all represented. Also making the list were two gold ETFs: the SPDR Gold Shares (GLD) and iShares COMEX Gold Trust (IAU).

Between the two of them, GLD and IAU hold nearly 40 million ounces of gold bullion, or more than 1,200 tonnes of the precious metal. That makes these ETFs one of the largest holders of gold in the world, behind France and ahead of China. GLD is the second largest U.S.-listed ETF, behind only SPY. While all exchange-traded commodity products have seen a surge in popularity, growth from gold ETFs has been particularly impressive: GLD alone saw cash inflows of more than $13 billion in 2009. Gold is one of the few natural resources with a high enough value-to-weight ratio to make physical storage by ETFs practical, enhancing their ability to track spot prices. Most other commodity products rely on a futures-based strategy, making them dependent not only on changes in spot prices but on the slope of the futures curve.

Needless to say, gold is a hot investment trend, and physically-backed gold ETFs have emerged as one of the most popular ways to gain precious metals exposure (see this guide to gold ETFs for a look at all the options).

But GLD and its competitors aren’t the only ETFs investors have embraced as a way to play gold prices. Two ETF products from Van Eck, the Gold Miners ETF (GDX) and Junior Gold Miners ETF (GDXJ), have seen their popularity surge as well.

Under The Hood Of GDX And GDXJ

GDX GDXJ
Large Caps 87.4% 0.0%
Mid Caps 9.4% 53.5%
Small Caps 3.3% 46.5%
Canada 60.9% 62.8%
U.S. 12.9% 17.6%
Source: Issuer fact sheets

GDX is designed to replicate the performance of the NYSE Arca Gold Miners Index, a benchmark that consists of publicly-traded companies involved in the mining of gold. As such, the profitability of the underlying holdings can be impacted significantly by the prevailing level of gold prices since spot prices directly influence the revenue derived from the company’s products. Since most gold miners maintain significant fixed expenses, increases in gold prices often drop directly to the bottom line, while declines directly result in a hit to net income.

So it’s not surprising that the correlation between GDX and GLD is strong, and that GDX often effectively serves as a leveraged play on spot gold prices with a beta of 1.85 compared to gold bullion (PDF).

GDXJ is impacted by many of the same factors that drive GDX, but its composition is entirely different. The Junior Gold Miners ETF focuses primarily on small and mid cap companies that derive at least half of their revenues from gold and silver mining or hold real estate that has the potential to produce significant revenues from gold and silver mining. Operations of junior miners cover a wide range, including companies that operate small scale mines and are engaged in defining gold or silver orebodies through drilling. Because many junior miners are yet to establish their ability to consistently generate revenues (and many produce negative cash flows), they can be very risky investments (read more about the differences in risk profiles between these funds here).

GDXJ is a relatively new fund, but has already become tremendously popular. Since it launched in November 2009, total assets have swelled to more than more than $800 million.

Volatility

GDX and GDXJ are two of the more volatile non-leveraged equity ETFs available to U.S. investors. Since its inception late last year, GDXJ has gained or lost at least 1% in nearly seven out of ten trading sessions and swung by 5% or more once every ten days. Over that same period, SPY moved by 1% or more about 34% of the time.

GDX and GDXJ also serve as effective leveraged plays on gold prices. Since its launch (which admittedly represents a limited time period), the median ratio of GDXJ’s daily performance to that of GLD is about 1.8, while GDX has exhibited a median “beta” over that period of 1.5.

While the volatility of these gold miner funds may make them inappropriate for investors with a low risk tolerance, it makes them an attractive option for investors looking to make a bet on gold prices. A quick look at the trading volumes of these funds indicates that most investors maintain a relatively short-term focus: the average holding periods for GDX and GDXJ are 6 days and 20 days, respectively.

Advantages and Drawbacks

Some investors favor gold miners ETFs because of the increased volatility and leverage offered. Others see these funds as a way to maintain exposure to gold while also investing in an asset with a positive long-term real return. As a hard asset, gold bullion will never make a dividend or interest payment, meaning that any return will come in the form of price appreciation. GDX, on the other hand, invests in a basket of stocks that will generally generate positive cash flows, providing some degree of current return.

On the other hand, because the underlying holdings of GDX and GDXJ are stocks and not commodities, the potential benefits of commodity investing may be muted somewhat. One advantage commonly cited by proponents of commodity investing–low correlations with existing asset classes–is diminished somewhat by holdings in GDX and GDXJ. The correlation between GLD and domestic and international equity markets has historically been close to zero, providing diversification benefits to investors when added to a traditional stock and bond portfolio. While gold miners ETFs won’t move in lock step with equity markets, they will maintain a significantly higher correlation with the S&P 500 than spot gold prices.

For investors looking to invest in gold, there’s no universally right answer. GDX and GLD offer unique risk and return profiles, and may be effective at accomplishing very different objectives. For more ETF ideas, make sure to sign up for our free ETF newsletter.

Disclosure: No positions at time of writing.