Monday, 7 March 2011

A Junior Gold Mining Index

Those investing in junior gold miners or explorer/developers may scan through their own little universe of stocks they have invested in or are planning to do so. They certainly look at graphs providing the necessary view on historic performance, they compare stocks against one another, but unlike gold mining majors followed by a few precious metal mining indices, there isn’t really an accepted benchmark for juniors. You can read below my comment on this problematic topic:

Comment on problematic Junior Mining Indices:
As for your second question:
Explorers and juniors have been outperforming majors ever since the 2008 implosion. What is quickly forgotten is that they were beaten up even more than the majors in their descent into the abyss. Resources, especially inferred resources, were valued less relative to proven reserves after 2008 than they were before. It seems that since last autumn this valuation ratio starts shifting again. Terribly hard to quantify though.
Junior/explorer indices are less evident: the population changes more frequently through M&A or ... bankruptcies and delistings. Very few successful juniors make it to become large producers, claiming their place in the PM miners’ indices. However, those which eventually make it, should they then be removed from the junior index (upon their successful growth, they’re no junior any longer)? Will a junior index be biased because of such composition changes?

In the GDXJ workshop

Yet there is at least some kind of Junior Gold Mining Index: GDXJ, the junior mining ETF, is using it as a benchmark. I again refer to a prior posting (both on the Kitco forum and on this blog):
GDXJ or GLDX, what to choose in the Gold Exploring Realm?
The GDXJ ETF issued by Van Eck has become a reference for precious metals mining investors. Launched only 15 months ago, GDXJ has grown to 2.18 Billion $ by Feb. 7.
It counts 60 different positions among explorers & developers and some emerging or intermediate producers. GDXJ counts four silver miners in its top 10 holdings, among which Hecla is the largest holding. Van Eck has had a major success before with its GDX major gold miner ETF and most probably investors felt reassured because of this.
Nevertheless, the success of GDXJ was certainly due mainly to its excellent performance over 2010, where it outperformed both the major miners and bullion gold. GDXJ seeks to replicate the Market Vectors Junior Gold Miners Index, the Factsheet mentions. The reference index and the ETF sharing the same corporate background, that doesn’t mean a lot.
Perhaps I’ve been too critical on the GDXJ benchmark index without at least giving it a closer look. On independence: Van Eck is not constituting their GDXJ benchmark “Market Vectors Junior Gold Miners Index” (MVGDXJ) themselves. Instead they have outsourced that task to 4asset-management. The URL below gives you access to some documentation on that proprietary benchmark:
The index has a Bloomberg and Reuters ticker and can be followed by professionals having access to those data sources. Historic data can also be retrieved from the 4asset-mgt website.
The methodology is explained on a fact sheet. Some excerpts:
·     The index includes all small-cap companies of the segment that generate at least 50% of their revenues from Gold or Silver Mining, companies with properties that have the potential to generate at least 50% of their revenues from gold and silver when developed or companies that primarily invest in Gold or Silver.
  • In addition, stocks must meet strict size and liquidity requirements: The full market capitalisation has to exceed USD 150 million, the three months average-daily-trading volume must be higher than USD 1.0 million and the stocks must have traded least 250,000 shares per month over the last six months.
Index data have been calculated back to 31 December 2003. The index starts at 1000 on that date. This offers a quite longer time series than the GDXJ ETF which was the first in its kind, when launched in autumn 2009.
The methodology has at least something reassuring: the index does not contain “micro caps” below $150 M in market cap. Micro caps can be very volatile: few might explode in value but more may face bankruptcy or be diluted into oblivion. Inclusion of micro caps would require very frequent index adaptations. Absence of micro cap also implies that those investors targeting these speculative stocks are not well served with an investment vehicle like GDXJ.
There is a lower market cap boundary, but no explicit upper boundary is mentioned. This is not evident: imposing an upper (exit) market cap boundary would require GDXJ to sell a successful stock after its share passes a threshold market capitalization. The GDXJ fact sheet mentions that it focuses on mid-tier precious metal stocks, with a market cap between $1 and 5 billion.
Secondly, I would expect the entry and/or exit boundary to float in lockstep with the index value. After valuations have multiplied, a $150M entry ticket may be easier to get: plenty of micro caps making it to the small cap segment, with the increased value of their resource base as the only merit. At the other hand, many financially sound explorers may have fallen below a market cap of $150 million during the October/November 2008 stock market implosion.
The basket of stocks making up the MVGDXJ is also published by 4asset-management. It contains some 58 mining stocks, together with their closing values (of a recent reference date), market caps and free-float adjusted market caps.
How did the index perform? Below you find a graph since the start:

MVGDXJ since the start on December 31, 2003 (click to enlarge)
PM stocks had run ahead of gold prices in the early bull years and December 2003 marked an end to that successful period. The index had a hard time, staying below 1000 for two years. The leaf was turned in 2006-07, with the index making it to 2500, a 150% gain. That brings us to another graph over nearly four years:
MVGDXJ since the maximum in November 2007 (click to enlarge)
Unlike major gold miners which kept on climbing until September 2008, juniors lost some élan well before that: the MVGDXJ peaks late in autumn 2007 and gradually loses ground into 2008. Moreover mining juniors ended crushed into the October 08 abyss. The MVGDXJ fell by over 80% from the November 7, 2007 top at 2542 to the November 20, 2008 bottom at 480. Junior miners were twice cheaper back in October/November 2008 than they were five years before, with a gold price nearly doubling over that same time span.
“The market can remain irrational for longer than you and I can remain solvent” is what Keynes keenly observed back in the 1930’s. Yet, the gold bull just retreated to make another jump. The quick recovery of the gold price saved juniors from total devastation… and junior mining investors from insolvency.
The recovery went swiftly until end 2009. January 2010 brought a major correction, as did last January. The February to May 2010 rally is again questioned in the summer doldrums: The MVGDXJ keeps lingering on below the November 2007 maximum. In autumn 2010 we witnessed the most powerful gold rally in years, with the MVGDXJ making a new high on December 6 at 3283.
Further reading:
Lorimer Wilson (2009), Comparing and Evaluating the HUI, XAU, GDX, XGD and CDNX: or

More similar papers are linked to in the top section of the list of blog articles.
On this very same topic, you find:
Junior precious metal mining outperform (March 21, 2011 - This Blog - Comparison between the Philadelphia Gold&Silver Miners index (^XAU) and the MVGDXJ)

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