Gold News

Junior Gold Mining Risk

Investing looking for leverage to Gold Prices often turn to the junior miners...


SO THE RISK
trade is on again, says Brad Zigler at Hard Assets Investor.

You can tell that by watching the Gold Miners Ratio, a fraction that compares the relative weight of the Market Vectors Gold Miners ETF (NYSE Arca: GDX) to its younger sibling, the Market Vectors Junior Gold Miners ETF (NYSE Arca: GDXJ).

The "senior" fund comprises 30 established Gold Mining producers, while the "junior" portfolio includes 60 issuers, mostly companies engaged in the exploration and development of gold properties.

The miners' ratio uses GDX's share price as its numerator, while the market value of GDXJ is the denominator. Presently, the ratio's in the 1.60 area, which is a historic low. Simply put, the price of the junior fund has been rising relative to the senior portfolio since July.

Hence the risk.

Over the summer, investors hoping for leveraged gains were much more willing to suffer the vicissitudes of early-stage Gold Mining ventures. And why not? The junior fund, GDXJ, handily outperformed the producer portfolio and even the price of bullion itself this year.

That doesn't necessarily mean the GDXJ portfolio was the best way for investors to obtain gold exposure.

In fact, when overlaying a modest allocation of gold to a balanced portfolio of stocks and bonds, it doesn't really matter what kind of product you use. Junior stocks, producers' shares and Gold Bullion itself all foster the same portfolio return. Only the risk undertaken is different.

A fund is only as "good" as its component stocks. There's a vast difference – along several dimensions – between the stocks making up the junior portfolio and those comprising the producer product.

By comparing the top five constituents of each portfolio, we can get a better sense of the internal forces at work.

GDX - Gold Miner

 

YTD
Return

Annual
Volatility

Downside
Semivariance

Sharpe
Ratio

Beta vs.
Gold

Portfolio
Weight

Barrick Gold Corp.

23.4%

31.5%

18.4%

.74

1.38

16.4%

Gold Corp. Inc.

14.8

33.7

19.2

.44

1.47

11.5

Newmont Mining Corp.

36.8

31.8

17.3

1.15

1.32

10.9

AngloGold Ashanti Ltd.

18.3

31.9

18.1

.57

1.33

5.9

Kinross Gold Corp.

6.3

35.1

20.5

.17

1.44

5.2

Mean

19.9%

32.8%

18.7%

.61

1.39

 

By and large, there aren't real "standouts" among the top tier of gold producers. Most portfolio metrics, save for their Sharpe ratios, are fairly uniform. That shouldn't be too surprising for established companies.

But a couple of the metrics probably bear explanation...

  • Downside semivariance is the standard deviation of daily losses. It's often said that volatility is a two-edged sword: Upside moves are considered just as risky as downturns;
  • Downside semivariance accounts for only the "bad" volatility. A skew in the semivariance metric from the stock's volatility midpoint gives an investor a better sense of the security's real risk. Note, for example, that the downside semivariance of Kinross Gold Corp. (NYSE: KGC) is more than half its annualized volatility. KGC was a stock more likely to have "down" days than "up days";
  • Sharpe ratios express a stock's risk-adjusted excess return; that is, its gains over a risk-free investment, factoring in its volatility. A ratio above 1.00 represents an excess return greater than the stock's risk;
  • Here, each stock's beta, or relative variance, is set against gold's. Positive readings indicate a directional correlation to bullion. A beta over 1.00 indicates the degree of excess volatility over gold's.

Now compare and contrast.

GDXJ - Junior Gold Miners
 

 

YTD
Return

Annual
Volatility

Downside
Semivariance

Sharpe
Ratio

Beta vs.
Gold

Portfolio
Weight

SEMAFO Inc.

131.2%

49.1%

25.5%

2.67

.04

5.3%

Allied Nevada Gold Corp.

84.8

48.5

28.5

1.74

1.86

4.3

Alamos Gold Inc.

33.8

40.4

22.5

.83

.10

3.7

Coeur d'Alene Mines

11.7

49.6

29.8

.23

1.89

3.5

Silver Standard Res.

2.4

39.3

23.3

.06

1.43

3.4

Mean

52.8%

45.4%

25.9%

1.11

1.06

 

There's a lot more variability in the juniors' performance, which is reflected not only in the spread of returns, but also in their Sharpe ratios and betas.

Clearly, China's SEMAFO, Inc. (TOR: SMA) was an outlier. Its beta may bear explanation, though; the number is so low because the stock tends to "zig" when gold "zags". In large part, this is a currency effect, as SEMAFO and Alamos Gold Inc. (TOR: AGI) trade in Canadian Dollars.

Notably the junior miners' volatility, as well as their downside semivariance, is uniformly higher than that of the larger Gold Mining producers. And taking a slice off the top, each miner group leaves us with this: Yes, you'll likely get a better return from juniors in a bull market for gold, but you'll pay for it with higher volatility and downside risk.

The question you have to ask yourself is whether you're nimble enough to lift your portfolio exposure to these high-speed stocks before they can have a deleterious effect on your wealth...

Get the safest Gold Bullion at the very lowest costs – cash price only, no leverage – by using world No.1 BullionVault...

Hardassetsinvestor.com is a research-oriented website devoted to sharing ideas about investing in the natural resources sector. Published by Van Eck Associates Corporation, the site offers an educational resource for both individual and institutional investors interested in learning more about commodity equities, commodity futures, and gold – the three major components of the hard assets marketplace.

See full archive of Hard Assests Investor.
 

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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