GDXJ Rebalancing to Leave Smaller Gold Stocks in the Cold


The VanEck Vectors Junior Gold Miners ETF (GDXJ) is at regulatory risk due to its success. Let me explain, the approximate $5.4 billion in assets under management (according to ETF.com) has become too big for its index, the MVIS Global Junior Gold Miners Index. As investor cash flows in the ETF increase, the fund is now faced with the task to either sell huge swathes (estimates of $2.6 billion worth) of smaller-cap issuers or expand the scope of its index and the size of issuers it contains. Regardless, a rebalancing of Canada’s junior gold stock index is in the cards. Those invested in junior gold stocks on the TSX or TSX Venture should be aware of everything surrounding this rebalancing. More specifically, which holdings have a greater chance of being liquidated is the question to answer. But first, some context.

GDXJ ETF has Deep Ties to TSX Venture

 

The GDXJ ETF as many of our TSX Venture investing community knows, is filled with gold stocks from Canada’s junior and senior exchange. Additionally, it holds huge positions in many of the top tier gold mining stocks from around the world. The ETF’s expanding positions and assets under management have put it at risk of violating certain Canadian and U.S. regulatory thresholds. An article by Sumit Roy from ETF.com explains,

 

“To avoid crossing those thresholds, the ETF bought up stocks of companies that aren’t in its index — creating a significant divergence between the ETF components and the index components.”

 

The article also warns that, “As much as 60 percent of the fund’s underlying index may change.”

Investors who love to trade the GDXJ to avoid the risk a single gold mining issuer carries may want to wait until the next rebalancing period to see how the GDXJ trades and is valued.

A rebalancing of this size is rare and is sending a clear signal regarding the appetite for gold stocks. Below are some quick stats from a Zacks Equity Research piece:

 

“Assets in this fund grew to $5.3 billion from approximately $1 billion in early 2016. The fund has garnered $1.42 billion in the year-to-date time frame. Moreover, the rebound in the price of gold led GDXJ to reach $36.14 on April 17, 2017 from $19.80 at the start of 2016.”

 

You see, VanEck (which runs both the ETF and index) was already adding huge positions, putting it at risk of violating certain thresholds and was forced to respond, issuing a press release last week announcing plans to broaden the index. The index many junior resource investors have come to love will soon include “many more gold miner stocks in the portfolio at the next rebalance date.”

source: http://www.cnbc.com/2017/04/18/popular-gold-miner-etf-to-change-dramatically.html

 

While this sounds good, the reshuffling may include dumping smaller market cap gold stocks for larger ones. To keep the weightings of certain holdings within the ETF within the stated investment objective, VanEck must increase the size and number of holdings it allows.

 

More specifically, ETF.com went on to explain that,

“The changes to the index will result in a dramatic transformation of GDXJ’s portfolio. Scotiabank estimates that, after the changes, there could be 23 new additions to the index (four of which are already in the ETF). Those 23 new additions could represent 60.8 percent of the new index portfolio.”

So, the GDXJ is getting one serious make-over after a year of huge gains.

 

GDXJ – 5 Year Chart

GDXJ 5 Year Chart

 

According to InvestorPlace.com,

 

“GDX has a three-year standard deviation of just over 46%, which is more than quadruple the comparable metric on the S&P 500.”

 

This is the volatility of gold stocks. For Canadian miners and investors, which dominate the assets under management for the GDXJ, this is a big deal. Check out the GDXJ’s country weightings as of March 31st, 2017:

 

GDXJ holdings breakdown
source: www.vaneck.com

 

Many of Canada’s most successful junior gold stocks comprise the ETF’s top 10 holdings.

GDXJ Top 10 Holdings
www.vaneck.com

 

In a Zero Hedge article titled The Real Message From The GDXJ Mess, Bloomberg explains,

 

“The world’s second-largest exchange-traded fund linked to material producers has become the victim of its own success.”

 

Bloomberg quoted Sameer Samana, a St. Louis-based global quantitative strategist at Wells Fargo Investment Institute, which oversees $1.8 trillion, who said,

“This is the curse of success.” And that, “They’re starting to run into issues of how much they own in certain names, how many names qualify for the index and they’re running into issues of how big the fund has gotten.”

ETF.com has estimated that, “As much as 60 percent of the fund’s underlying index may change.”

Zero Hedge reported further that,

 

“Faced with all these problems, VanEck chose to dramatically alter the composition of the underlying index that GDXJ is supposed to track. They announced their intention to make these changes on June 17th, but in the meantime, have released their new guidelines for the index.”

 

The ultimate question: who will stay and, most importantly, for those invested in not only the GDXJ, but individual gold stocks held by the ETF, who will go?

TD Index Research Group Sheds Light on GDXJ Rebalancing

 

TD’s index research group may have found the answer and has projected flows arising from the coming GDXJ index rebalance.

First the potential additions:

GDXJ may add issuers
source: http://www.zerohedge.com/news/2017-04-19/real-message-gdxj-mess

 

Next, the potential deletes: (this is critical because these stocks could be under pressure until the June rebalance).

 

GDXJ to be rebalanced
source: http://www.zerohedge.com/news/2017-04-19/real-message-gdxj-mess

 

Zero Hedge concludes that,

 

“In the coming weeks, the stocks underlying the GDXJ ETF will have the constituent members decline due to the selling, and the members with increased weightings (and new additions) will see their share prices increase. Of course this will all be on a relative basis. But taken together, this large demand for liquidity will result in GDXJ returning much less than would be the case had there been no index rebalance.”

Click here to read the entire article titled The Real Message From The GDXJ Mess.

 

The GDXJ has long been the barometer of changing winds for the TSX Venture and, of course, gold stocks. The growth of the index should at least confirm interest in this tiny space is increasing. Gold stocks led the current rally in gold and have paused in recent sessions. The approximate 5-fold increase of assets under management owned by the index from $1 billion in early 2016 to $5.4 billion highlights how easily gold stocks can increase when new money flows into the space. The rebalancing and expansion of the GDXJ is likely a harbinger of things to come in this sector.