Soaring Gold Price Boosts Gold Miner ETFs

by on June 9, 2010 | ETFs Mentioned:

Equity markets have been slumping as of late, as worries of a sovereign debt crisis in Europe have weighed heavily on global markets and caused many investors to curtail their exposure to euro-denominated assets. The U.S. market seemed to be a viable “euro free” alternative, but a weak job report last week has called into question the sustainability of the current recovery, at least in the short-term. This combination of negative developments has sent investors flocking to safe havens, and many have been piling into precious metals as a way to protect their portfolios against weak equity markets and anemic bond yields (see Five Safe Haven ETFs). This wave of risk aversion pushed gold to a record closing price on Tuesday, as the yellow metal finished the day at $1,245/oz., the highest price on record since gold futures started trading in the 1970′s.

In addition to surging demand from gold ETFs (such as GLD, which currently has almost 1,300 tons of gold in its holdings), foreign central banks have been clamoring for more of the metal as well. And with good reason; India and China hold just 6% and 1.5% of their reserves, respectively, in gold, suggesting that they are due for a period of diversification away from fiat currencies. Additionally, Iran joined this trend announcing it would sell 45 billion euros for U.S. dollars and gold, further adding to the bullishness on gold and the negative outlook for the euro (see How Big Can The Gold ETF Get?).

In addition to broad buying from both retail investors and central banks, debt crises have tempered risk appetites for many investors. While emerging nations in Europe have been at the focus of the debt crisis, many are growing increasingly concerned that the contagion could spread to more developed markets. Early on Tuesday, comments from Fitch that the U.K. fiscal challenge is “formidable” ahead of Chancellor of the Exchequer George Osborne’s speech, sent investors once again seeking safe-harbor from the current financial storm. “We see people buying gold for safety. Gold is in effect trading as a currency,” said Frank Lesh, a broker and analyst at FuturePath Trading in Chicago. “Every couple of weeks you hear about more (sovereign) debt problems from a different country.”

Some of the biggest beneficiaries of the recent run-up have been gold mining ETFs; the Market Vectors Gold Miners Fund (GDX) and Market Vectors Junior Gold Miners ETF (GDXJ) have both been trading as leveraged plays on bullion in recent sessions. Despite market turmoil over the last two weeks, GDX was up more than 5% while GDXJ tacked on 3%, making these funds among the few equity ETFs that have benefited from the recent chaos in stock markets.

For investors with a bearish outlook, precious metals are obviously appealing. But some are hesitant to make big allocations to an asset that has no potential to ever make a dividend or coupon payment. Because the profitability of component companies depends in large part on the market price for gold–especially when many miners are scaling back hedging activity–GDX and GDXJ tend to maintain a high correlation with gold prices. But because the underlying assets are equities and not bars stored in a vault, they have the potential to generate cash. GDXJ currently has a dividend yield of 1.9% while GDX pays out about 0.6%.

For information on the key differences between GDX and GDXJ, see GDX vs. GDXJ: Better Ways To Play Gold? For more ETF news make sure to sign up for our free ETF newsletter.

Disclosure: No positions at time of writing.