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Friday, February 18, 2011

Bottom Line: Stick With The Juniors In Gold ETFs (GDX, GDXJ, GLD)

In covering the gold sector for my premium subscribers, I have  noticed something lately. The large-caps really suck! Ok, that is harsh  but it is the truth.

In the chart below I show the large-cap indices. What do you see?

The Dow Jones Precious Metals Index hasn’t gone anywhere for five  years, while Gold has m
ore than doubled. The next two the XAU and the  Market Vectors Gold Miners ETF (NYSE:GDX) are trading right at their  2008 peaks. Since then, I quickly calculate that Gold and Silver are  higher by about 33%.

We all know that the Market Vectors Junior Gold Miners ETF  (NYSE:GDXJ) outperformed GDX in 2010. It wasn’t close and even during  this correction GDXJ is holding up better.
Yet, GDXJ is weighted heavily in some companies that are above $1  Billion in market cap. Where is the “junior” in that? I created my own  index of 25 gold stocks, which are equally weighted and range mostly  from $200-$700 million in market cap.

My junior index against the HUI (GDX follows the HUI) is moving  higher after an 8-year breakout. This chart tells us that the juniors  should outperform strongly in 2011 and likely 2012.

We’ve written about this before but it bears hearing again.

Too often we hear about how gold stocks are cheap and how they are  priced for $1000 Gold or $800 Gold. Just because the HUI/Gold or  XAU/Gold ratio is low doesn’t mean the sector is at a bottom. The  reality is that large gold stocks have consistently underperformed Gold  over time. Take a look at this piece from Steve Saville and his chart which goes back to 1960.

Steve attributes the poor performance to rising costs, management  errors, environmental and political factors but most importantly,  depletion. Just to stay in business gold companies have to consistently  find new deposits, mine those deposits and add to reserves. The larger a  company is, the more difficult it is to do these things. A junior  company can grow by building a few small mines. A large-cap needs to  find huge deposits that can become huge mines. It is simply a more  difficult business for the larger sized companies.

It is critical that investors and speculators take note of all these  factors before partaking in the sector. I fear that the new entrants in  the sector will think they are safe by buying Newmont or Barrick. They  may be less volatile, but history argues you are better off holding Gold  or Silver.

Sure the juniors have already had a fantastic run, but our chart  argues that it may be even better in the next few years. As the bull  market rages on, the herd will naturally become more speculative. The  large players have begun to resort to takeovers and acquisitions. This  will continue and further catalyze the junior sector.  Related ETF: SPDR  Gold Shares ETF (NYSE:GLD)

Disclosure I am long IAU and SLV shares.

1 comment:

  1. Excellent suggestion. Exchange trade funds that invest in junior gold mining stocks protect you from being in one really bad stock.